Does Transfer To A Cottage LLC Uncap The Taxes?

Will he lose his future cottage to property taxes? A Michigan cottage’s real property tax can increase DRAMATICALLY on a “transfer of ownership.” This article discusses whether the transfer of your cottage to a limited liability uncaps the taxes.As Michigan property owners know, property “uncaps” (usually resulting in a SIGNIFICANT increase in future property taxes) when there is a “transfer of ownership” of the property. Events that are considered transfers of ownership are defined by Michigan law. The Michigan Treasury Department has issued “Guidelines” that interpret the “transfer of ownership” law.Many families would like to use a limited liability company or other entity to hold title to a cottage. A frequent question is whether transfer from the individual property owners to the limited liability company will uncap the taxes. The answer is “no” so long as the LLC initially is owned EXACTLY in the same proportions by the same people who owned the real property.The applicable statute [MCL § 211.27a(7)(l)] provides an exemption (from being a “transfer of ownership”) in cases of:A transfer of real property or other ownership interests among corporations, partnerships, limited liability companies, limited liability partnerships, or other legal entities if the entities involved are commonly controlled. Upon request by the state tax commission, a corporation, partnership, limited liability company, limited liability partnership, or other legal entity shall furnish proof within 45 days that a transfer meets the requirements of this subdivision.

The Guidelines liberalize this section somewhat. For instance, a literal reading of the statute would treat transfer of real property to a limited liability company owned 100% by the transferor as a “transfer of ownership.” The statute only exempts transfers AMONG entities. It does not exempt the initial transfer TO an entity. In the following example the Treasury recognized that it was not the Legislature’s intention to uncap the taxes if there is no change in beneficial ownership of the property (as would be the case if a person transferred ownership of a property to an LLC, and then owned the LLC).

[QUOTATION FROM TREASURY GUIDELINES]

Is it possible for entities not to qualify as entities under common control under Michigan Revenue Administrative Bulletin 1989-48 yet still be considered entities under common control?

Yes. In the opinion of the State Tax Commission, the following circumstances constitute a common control situation—even though the entities involved may not qualify as entities under common control under Michigan Revenue Administrative Bulletin 1989-48: Property (or an ownership interest) is conveyed from one entity to another entity and both entities are owned by the same individual(s) with the same percentage of ownership. Property transfers (or transfers of ownership interests) under these exact circumstances are considered to be transfers between commonly controlled entities and not transfers of ownership.

Example: Individual A and individual B own a lakefront cottage property together as tenants in common, each with an undivided 50 percent interest. This is the only such property these individuals own and they use the property solely for recreational purposes, residing there from time to time. For liability protection purposes, individual A and individual B convey the property to a limited liability company. Individual A and individual B are the only members of the limited liability company, each having a 50 percent ownership interest. Even though these entities (individual A, individual B, and the limited liability company) are not entities under common control under Michigan Revenue Administrative Bulletin 1989-48, these entities are considered to be under common control by policy of the State Tax Commission and this property transfer would not be a transfer of ownership.

[END OF QUOTATION]

It is therefore the policy of the Michigan Treasury Department to permit exchange of interests in real property for an equivalent interest in a limited liability company without causing the property taxes to uncap.

For example, if four equal owners of a cottage transfer their interests to an LLC, and each receives a 25% interest in the LLC, then under current Michigan Treasury policy there is no uncapping.

When does a property owned by an LLC uncap?

The property will uncap when more than 50% of the LLC interests are transferred (whether by virtue of an owner’s death, sale, gift, or otherwise). It is not possible to avoid uncapping indefinitely, but it can be postponed for a long while.

Michigan law requires uncapping (increasing the taxable value to the state equalized value) in the year following a “transfer of ownership.” MCL § 211.27a(6)(h) definines of “transfer of ownership” as:

(h) A conveyance of an ownership interest in a …limited liability company …if the ownership interest conveyed is more than 50% of the …limited liability company. Unless notification is provided under subsection (10), the … limited liability company… shall notify the assessing officer on a form provided by the state tax commission not more than 45 days after a conveyance of an ownership interest that constitutes a transfer of ownership under this subdivision.

The Michigan Department of Treasury, State Tax Commission, Property Tax Division’s March 31, 2001, publication “Transfer of Ownership and Taxable Value Uncapping Guidelines” provides these examples of the application of this law:

[QUOTATION FROM TREASURY GUIDELINES]

Can the conveyance of an ownership interest of a legal entity (such as a corporation, a partnership, etc.) which owns property be a transfer of ownership—even though title to the property remains unchanged?

Yes, a conveyance of an ownership interest in a legal entity (such as a corporation, a partnership, etc.) which owns property is a transfer of ownership of that property provided that the ownership interest conveyed is more than 50 percent of the total ownership interest (and provided that no statutory exception or exemption applies).

A conveyance of 25.0 percent of the ownership interest in a limited liability company was completed in 1999. In January of 2000, a conveyance of 25.1 percent of the ownership interest of the limited liability company occurred. The limited liability company owns real property. Did a transfer of ownership of the real property occur? If so, when?

Provided no statutory exception or exemption applies, a transfer of ownership of the property owned by the limited liability company occurred in January of 2000 since, at that point, more than 50.0 percent of the ownership interest in the limited liability company had been conveyed. The property’s taxable value is to be uncapped for 2001. Note: These circumstances are to result in the total (100 percent) uncapping of the property’s taxable value for 2001. A partial (less than 100 percent) uncapping is not authorized in this situation.

As of January of 2000, 50.1 percent of the ownership interest of a limited liability company had been conveyed and the taxable value of the property owned by the limited liability company was uncapped for 2001. If, in March of 2002, 50.0 percent of the ownership interest in the limited liability company is conveyed, does another transfer of ownership occur?

No. The percentage of ownership interest conveyed is cumulative from the date of the last transfer of ownership. Between January of 2001 and March of 2002, not more than 50.0 percent of the ownership interest is conveyed. Therefore, no transfer of ownership occurs as of March of 2002.

[END QUOTATION]

Thus, under current law, the current generation of LLC owners COLLECTIVELY may give up to 50% of their membership interests to the next generation without triggering uncapping. If several branches of the family own membership interests, the members might agree among themselves that no single branch may transfer more than 50% of its interest during the current owner’s lifetime. A rule such as this could be incorporated into your family’s operating agreement. Absent such a rule, if one owner gave away all of his interest, then another owner might cause uncapping by transferring only a small part of that owner’s interest in the LLC. Gifts of LLC interests (or any cottage interest) should not be made without carefully considering the property tax ramifications in states like Michigan and California.