Changes to property tax laws could affect cottage owners
Thinking about passing the family cottage down to the next generation? Changes to Michigan property tax laws that go into effect New Year's Eve could put some property owners at a disadvantage if they don't think through some key questions.
First, a little background: As you may know, Michigan law includes a cap on the annual increase in property taxes. The value used for determining property taxes can increase by no more than the rate of inflation or 5 percent if lower, even if the actual increase in value was greater. As a result, those who have held their property for a long time are likely paying tax as if the property was worth much less than its true value.
That cap comes off, though, when there is a transfer of ownership. Upon a transfer, the taxable value jumps to the fair market value, which is then capped at that level for the new owner.
The main place this comes into play is with a cottage or other heirloom property that is intended to stay in a family generation after generation. For many families, it’s important to keep this cap in place as long as possible.
If uncapped, the younger family members may find themselves paying a much higher property tax bill than prior family members did. In some cases, an uncapping of the property taxes may make it difficult for a family to continue to own the property.
Last year, Michigan enacted new legislation to add an exemption from uncapping for transfers of residential real property to people who were related “by blood or affinity to the first degree.” In addition to a transfer to a spouse, for which an exemption had always been available, the state interpreted this antiquated phrase to cover transfers to parents, step-parents, siblings, children, step-children and parents of a spouse.
The exemption, however, only applied if the use of the property did not change after the transfer. Additionally, the state interpreted the rule to apply only to transfers made by a living person — not resulting from the prior owner’s death. This presents a challenge, as many families don’t necessarily want to pass property down to their children or grandchildren while they are still alive.
In October, the Michigan Legislature decided to replace the Buzz Lightyear-like "blood or affinity to the first degree" language with a broader and easier-to-understand set of exemptions based on family relationship. The new exemption will go into effect Dec. 31.
It will exempt transfers to parents, siblings, children and grandchildren. The inclusion of an exemption for transfers to grandchildren is new. The new exemption also will cover transfers that take place at death and transfers that are made through a trust in a way that is much more taxpayer-friendly than the current exemption.
Although this change generally provides more flexibility for keeping property taxes capped, there are a couple of specific situations where the change will have a potentially adverse effect. The new exemption:
1. Does not cover transfers to step-parents, step-children or parents of a spouse, who would have been exempt under the current “blood or affinity to the first degree” exemption.
2. Has a stricter test relating to the commercial use of the property after the transfer. The current exemption only requires the use of the property to not change. If there was some prior commercial use of the property — such as occasional rental to third parties — the exemption from uncapping would be available and the commercial use could continue. Under the new exemption, there can be no commercial use of the property following the transfer, regardless of whether there had been in the past. The state has not provided specific guidance on what will be treated as commercial use, whether there will be any exception for incidental commercial use, or for how long after the transfer the prohibition on commercial use remains in effect. These will be important issues for the state to clarify and for property owners to monitor.
For owners of heirloom property who intend to pass ownership to step-relatives or to in-laws or for which there is expected to be a continuing commercial use, it will be important to consult with a knowledgeable attorney.
Todd W. Simpson is a partner at Warner Norcross & Judd LLP who concentrates his practice on tax and estate planning. He can be reached at email@example.com.