After a week of fun at the family vacation home with your relatives, it is natural to be pondering feasible ways to keep that home in the family for the next generations to enjoy. Unfortunately, a Michigan Court of Appeals decision, regarding ownership of property by a family LLC, adds a layer of complexity to your options for transferring a family cottage or vacation home in Michigan.
Transferring a Vacation Property to an LLC Has Been Common
For years, families have transferred their Michigan vacation homes to limited liability companies (LLCs) owned by them for a variety of reasons, including:
One of the reasons this practice has been common, is that this type of transfer was typically not thought to raise a property’s taxes like a sale of the property could do.
Understanding Property Tax Uncapping
Michigan’s “capping” of property taxes has allowed generations of families the affordability to continue ownership of properties, such as waterfront cottages, which have greatly appreciated in value over the years.
Michigan law places a restriction on the annual increase that can be made to the taxable value of a property (the dollar value you pay taxes on), generally capping increases to either the rate of inflation or 5 percent, whichever amount is less each year. However, following a transfer of ownership, such as a sale of the property, the taxable value of the property is “uncapped,” and the state equalized value (SEV) of the property generally becomes the new taxable value. The SEV is based on the assessor’s view of the current fair market value of the property.
If the property taxes have been capped for a generation or more, the disparity between the taxable value and the SEV could be quite large, and the property tax bills after uncapping would be significantly higher moving forward. Sometimes, this uncapping has been referred to as the “pop-up tax.”
Transfer of Ownership
Accidentally triggering a property’s “uncapping” by failing to understand Michigan’s property tax rules could be a costly mistake for families with high-value properties. As such, when making changes to property titles, families and their advisors have traditionally consulted the guidelines prepared by the Michigan State Tax Commission.
A number of iterations of these guidelines have indicated that a transfer of property between individuals and an entity owned identically by those same individuals (such as an LLC) is not a transfer of ownership, but rather a transfer between “commonly controlled” entities. Since a transfer of property between entities “under common control” is exempted from being a transfer of ownership in Michigan, the taxes on a property have traditionally stayed capped when transferring your property to your LLC.
The relevant section of the guidelines worked well over the years for Michigan property owners ─ until they didn’t.
Scott v. South Haven – A Potential Game Changer
In 2008, Joan Scott transferred her cottage from herself to an LLC, of which Scott was the only member, and in 2013 the LLC conveyed the cottage back to Ms. Scott. The city of South Haven called the transfer of the property from the LLC to Ms. Scott a transfer of ownership and uncapped the taxable value of the property, even though beneficial ownership was identical on both sides of the transaction.
The Scott family contested the uncapping, and the tax tribunal ruled in 2017 that the transaction was, in fact, a transfer of ownership because it was not a transfer between entities under common control.
The main issues in the case were a lack of definition in Michigan’s laws for the phrase “commonly controlled” and the need for an interpretation as to what constitutes a legal “entity.” In the end, the Court of Appeals essentially found that because Joan Scott owned the cottage for personal use and she did not conduct business as a sole proprietor (i.e. potentially, a legal entity), she was not a legal entity. As such, the property transfer was not considered to be between entities under common control. Since the ruling was that the Scott property transfer was not between commonly controlled entities, it was considered a non-exempt transfer of ownership, and the property was indeed subject to uncapping of taxable value.
What Does This Mean for Families With Michigan Properties?
The Michigan Court of Appeals affirmed the decision of the tax tribunal ─ that this was an uncapping event. Since the Court of Appeals decision was unpublished, it is not technically precedent-setting. But coupled with the fact that the Michigan Supreme Court recently declined to hear an appeal of this case, this decision does seem to offer a guideline for families that should not be ignored.
If you decide to transfer a family vacation home to or from a family LLC, you risk uncapping the property’s taxable value, which could lead to a considerable hike in your property taxes. It is important to weigh these tax implications against a transfer’s benefits when making this decision. Consult your Warner attorney or Loren Andrulis at 616.752.2182 or email@example.com for assistance with property transfer issues.