UPDATE ON PUBLIC ACT 497 OF 2012-UNCAPPING TRANSFERS OF PROPERTY

On December 16, 2013, the Michigan State Tax Commission issued Bulletin 23 which deals with transfers of ownership of real property and the impact on taxes assessed on transferred property.  The State Tax Commission is a 3 member agency appointed by the Governor that has general supervision of the administration of the property tax laws in Michigan.  It renders advice and direction to local tax assessors, who are the first line of enforcement of our property tax laws.

You will recall that Public Act (“P.A.”) 497 was passed and signed by Governor Snyder last December, and created exemptions from the “uncapping” of property values for property tax purposes on transfers of ownership between certain individuals.  A great deal of uncertainty was created by the new law, and we have been waiting for further clarification on it.  In general, the new law provides that a transfer of ownership of property is not a transfer for uncapping purposes if the transferee (person receiving ownership) is related to the transferor (person transferring ownership) by blood or affinity to the first degree and the use of the property does not change.

Bulletin 23 issued on December 16 defines “related to the first degree of blood or affinity” as persons who are your: (1) spouse; (2) father or mother; (3) father or mother of spouse; (4) son or daughter; (5) adopted son or daughter; (6) son or daughter of spouse; (7) siblings.

Bulletin 23 went on to say that the “blood relationship” clause of the law means that the transferee and transferor must be persons, and not entities.  It concludes that the exemption from uncapping does not apply (emphasis in original) to transfers by a trust, a limited liability company or to a distribution from probate.

Thus, according to the Bulletin, the only transfers that are covered by the new law are transfers made by owners with property titled in their own name made during the owner’s lifetime.  Distributions from a trust and inheritances under a last will and testament are NOT exempt.

This interpretation of the law will create some difficult choices for owners of vacation property.  In order to take advantage of the new law, the transfer of ownership must occur while the owner is alive.  This means giving up control over the property.  For owners who currently claim the Principal Residence Exemption (the so-called “Homestead” exemption), it may mean giving up that exemption, or at least determining which exemption is more valuable to the family.  It also means that the new owners will be “tenants in common” with no structure, direction, or guidance for managing the property.  See my blog post of September 19, 2013 or “Saving the Family Cottage, A Guide to Succession Planning” (Nolo Press, 4th ed., 2013), where I describe common issues that arise when property is owned as tenants in common.  For many families, the biggest disadvantage of this form of ownership is that it makes it impossible to insure that ownership of the property will stay in the family.  In addition, it means that any owner may force a sale of the property, at any time, for any reason, or for no reason at all.

The Bulletin also raises the question of what families can do if the property has already been transferred to a limited liability company, partnership or other entity.   The question is whether the property may be removed from the entity and transferred to the next generation of owners without “uncapping” the value and raising property taxes.  There is no clear answer to this right now, and it may be a while before more clarification is forthcoming.

For families where the only way the next generation of owners can afford to keep the property is to avoid uncapping, then the choice is fairly clear.  Ownership must be transferred before the current owner dies.  If the property is in a revocable or living trust, it is possible to remove the property from the trust and transfer it to the next generation without uncapping the value.  But, that must be done before the parents both pass away.  However, in doing so, parents must understand that they are giving the property in a way that carries with it considerable risk of future conflict among children on how to manage the property, and it has no assurances that ownership will remain in the family.

I want to point out that property taxes are only one consideration in passing on family vacation property to the next generation.  If there is no planning done on how the property will be handled when Mom and Dad are gone, there is a very high risk that disputes and conflict will arise within a short period of time after the transfer takes place.  Unfortunately, there are too many examples of families that have suffered permanent unhappiness and damaged relationships because of conflict over the family property.

As my September 19, 2013 blog post points out, there is already considerable opposition to this new exemption, and I expect that this opposition will oppose it to the point that they may attempt to repeal it.  If your family wants to take advantage of the new exemption, I strongly encourage you to take action as soon after January 1, 2014 as possible. We can make the transfer of ownership conditioned on the next generation entering into a co-ownership agreement containing some of the advantages of the limited liability company approach to ownership, or even conditional upon putting the property into an LLC after it is transferred to them and postponing the increase in property taxes for one generation.

If you would like assistance in planning on how to pass on property to the next generation of family members, please contact my office.

Comments

  1. Sean O'Bryan says:

    If a property is currently in a parents trust, and they both die, could the children just leave the cottage in that trust until they decide to sell it say 10 or 15 year later – without having the property uncapped?

    • Michigan law currently provides that when property is titled in a trust, the value for property tax purposes “uncaps” on any change in the beneficiary or beneficiaries of the trust. If the parents’ trust provides that they are the beneficiaries during their lifetimes (as most trusts do), then the value “uncaps” on the death of the second parent to die, regardless of whether or not the property is distributed out of the trust. So, unfortunately for the children, the answer to your question is no, the uncapping of value occurs on the death of the second parent.

  2. Alan Jackman says:

    Is it possible that ownership interest in an LLC could be be transferred, consistent with both the LLC operating agreement and Bulletin 23’s definition of acceptable relationships, without uncapping?

    • By its terms, Bulletin 23 says that a transfer of ownership in an LLC, partnership or corporation does NOT fall within the exemption from uncapping provided by P.A. 497. Therefore, such an ownership transfer is not exempt from uncapping. Similarly, a change in trust beneficiaries and inheritance through a last will and testament is not exempt from uncapping either. I do not believe these results are consistent with what the Michigan legislature had in mind when it passed P.A. 497, but the way that law was written, and the narrow interpretation given it by the State Tax Commission, this result is not a complete surprise. I know that efforts are underway by the State Bar of Michigan to seek a clarifying amendment to P.A. 497 that would exempt transfers by a trust, a will, and ownership in an LLC, partnership and corporation, but at this time, such transfers will result in uncapping the value for property tax purposes.

  3. Caryn Mortimore says:

    Our family cabin is currently titled in my father’s marital trust. My mother is still alive. Is there any way that this property can be retitled to avoid property tax uncapping upon her death?

    • As long as the trust allows your mother to remove the property from the trust, and assuming she is the present beneficiary of the trust, the law will allow her to remove the property without uncapping the value. She would retitle it in her name, and then give the property to a relative of the first degree–her children, for example. That transfer can also be done without uncapping, providing the use of the property doesn’t change following the transfer. As Michigan law now provides, if she does not take these steps before she passes away, the property value with uncap at her death.

  4. Caryn Mortimore says:

    Just for clarification, to give the property to the child (children) the parent would either gift it or deed it, I assume quit claim deed. Would a quit claim deed in MI keep the IRS from coming in and assigning a fair market value for the property and then levying a tax against the child (children)? In addition, would it be possible that the child (children) would be liable for any capital gains tax on the property. (The cabin property was assessed at the time of my father’s death and that value was assigned when the property passed into the marital trust. )

    Alternatively, I cannot see anyway that this transaction could be completed by using the annual $14,000 gift tax exemption per child per year as it would take almost 5 years to “gift” transfer the cabin amongst 4 children and mom is approaching 90 years of age. And how would she possibly show that she is “gifting’ a $14,000 share in the cabin?

    If property could be quickly transferred to the children and then an LLC formed per your comment previously, just what determines the “next generation” for uncapping? If the oldest child dies and property passes to his children does that become the determining turning point for the “next generation” uncapping even though the other siblings are still alive with heirs of their own?

    • Regardless of whether the transfer is a gift or a sale, there will be no tax aeeseed against the children–any tax would be assessed against the parent making the transfer, in this case, your mother. However, in addition to the annual gift tax exclusion of $14,000 per recipient, your mother also has a lifetime gift tax exclusion of $5,340,000 this year. This means she could make the entire gift in one year, and any “value” in excess of the $14,000 per child would simply reduce her estate tax credit amount from $5,340,000 by the value of the gift. Gift tax and estate tax exemptions are combined, and together total $5,340,000 this year. The IRS is not bound by the value your mother assigns to the properyt for either gift or estate tax matters. If you have more questions regarding the tax consequences of making a lifetime gift of the property, I recommend that you consult with your parent’s income and estate tax attorney for specific advice based on their situation.

  5. Kimberly Dunbar says:

    My parents quit-claimed a home (my primary residence for the past five years) to me on November 27, 2013. The property tax was uncapped and the SEV and TV considerably increased. I’m told that, despite Act 497’s passage in 2012, it only took effect after 12/31/13.

    • The advice you received is correct. By its own terms, P.A. 497 (and the exemptions from uncapping) only applies to transfers that occur on and after December 31, 2013. The actual language of the statutes states “Beginning December 31, 2013,…” and it then goes on to describe the transfers that are exempt from uncapping. Unfortunately, your parents deed was about 5 weeks too early to avoid the uncapping.

  6. quiry:
    to paraphrase Hillary: What difference does it make!

    If the owner of realty transfers title to his son, and the son is not a resident of MI (resides at the subject realty) there is no longer a tax break which existed when the dad/owner resided there. In effect, does not the transfer of title to the son, and/or death of the owner result in the same result? No homestead exemption!
    The uncapped SEV results in the same realty tax as does the realty without the homestead exemption?
    Is this accurate or not?

    • The Homestead Exemption and property value uncapping are two distinctly different concepts related to property taxes, and they are independent of each other. To qualify for the Homestead Exemption, a person must live on the property and maintain his or her principal residence on it. Obviously, this means that he or she must be a Michigan resident. If an owner qualifies, the exemption reduces the property tax bill by 18 mills, a reduction that can mean as much as a 40% reduction in the annual property taxes. Uncapping refers to the increase in base value of the property for purposes of assessing property taxes when an ownership transfer occurs. Depending on how long the previous owner has owned the property, it can mean the new owner pays as much as 2, 3 or more times the amount of property taxes paid by the previous owner. This applies whether or not the property is the owners principal residence.

      It is possible that the two exemptions could be relatively close to each other in terms of dollar amounts. In your example, the owner was claiming the Homestead exemption on the property when the ownership was transferred. The son loses the Homestead Exemption because he does not live on the property. So the taxes go up by 40%. However, because ownership was transferred to a child of the owner, the value for property tax purposes does not go up, thereby avoiding a significant increase in property taxes. So the new owner pays more for the loss of the Homestead, but pays less because of the uncapping exemption. Whether or not these two adjustments are equal depends entirely on the value of the property and the millage assessed on all property in the Township. It would be exremely rare if they are identical in amount, because they are unrelated to each other, but it is theoretically possible.

      An even worse case is where the property is transferred to an individual who is not a child of the owner. Here, the new owner looses not only the Homstead Exemption, but the property value uncapps as well. In this case, the new owner may be paying 4, 5 or more times the amount of property taxes that the former owner paid. This just shows the value of good planning in transferring ownership of real property in Michigan.

  7. David Groh says:

    I have been reading many websites interpretation’s of the new Uncapping Property Tax Law, and I was wondering what the chances are, that a property, in a Trust will become Exempt from being Uncapped. In other words do you think the State of Michigan may change the newly adopted law? I am wondering this, as my families property is in a Revocable Trust, my mom died, and my siblings and I are working on closing the estate. My sisters may not be able to afford the taxes, if they double.

    • There is a bill pending before the Michigan State Senate right now that, if passed and signed into law, would exempt transfers of real property from a parent’s trust to children from uncapping so long as the use of the property doesn’t change after the transfer. This further change in the uncapping laws is expected to pass the Senate sometime this late summer or early fall and become effective after December 31, 2014. Thus, if the bill is passed and signed into law by Governor Snyder, a distribution of property from a parent’s trust to his/her children would be exempt from uncapping so long as the use of the property doesn’t change going forward.

      In your specific situation, however, please understand that the current law provides that property value uncapps when there is a change of beneficiaries of the trust that owns the property. If your mother’s trust owns the property, and if she was the beneficiary during her lifetime but has now passed away, the trigger on uncapping has alreayd occurred and any further amendment will likely not apply to your situation. You should review your specific case with an experienced real estate attorney to determine whether the trustee should notify the tax assessor of your mother’s death.

  8. Will this change in the cottage law that protects uncapping of property taxes that are transferred from a trust go into effect December 31, 2014?

    • The new law applies to transfers “beginning on December 31, 2014.” Thus, a transfer to an eligible person on or after that date will be exempt from uncapping so long as there is no commercial use of the property. At this point, we have no guidance on what constitutes “no commercial use” of the property.

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