New tax ruling could spell trouble for family cottages
Thinking of moving the family cottage to an LLC? How about doing the same thing with the property used in your business? A couple of new rulings from the Michigan Tax Tribunal may change the way you need to structure things.
Earlier this summer, two rulings came out in South Haven v. Scott et al and Lansing v. TRJ&E Properties LLC that call into question the way many have handled the transfer of real property in Michigan. A little history and a hypothetical situation will help explain.
First, the history: Since Proposal A became Michigan law in 1994, general increases in taxable values on property are limited from the point when the properties are bought until a transfer of ownership occurs, often via a sale or other transfer by deed. Once the property is transferred, its taxable value is “uncapped,” meaning the new owner will be taxed on the current value of the property.
Some call this a “pop-up tax,” and it effectively ends the tax benefits of keeping a property’s taxable value artificially low over what can be a long period.
A little more history: It’s a common practice to separate real estate holdings from the operations of a business. Many business owners will create a separate limited liability company to hold real property as a way to protect themselves — and their businesses — from potential lawsuits. It’s also becoming more common to move a family cottage to an LLC for liability protection purposes or as a way to preserve generational use and ownership into the future.
Now let’s look at the hypothetical: As part of a restructuring of her company, a business owner decides to transfer title to her business headquarters from the corporation that owns it to a separate LLC. She owns the business jointly with her husband, so they structure the LLC to have the same joint ownership.
When the property is transferred to this new entity, will its taxable value be uncapped? No.
This same business owner decides to put the family cottage she owns with her husband into an LLC. They also structure that new LLC to have the same joint ownership.
When the cottage is transferred into this new entity, will its taxable value be uncapped? The answer, according to the rationale of South Haven v. Scott, is a somewhat surprising yes.
Business vs. residential?
Key to both questions is what constitutes a transfer of ownership within the meaning of the relevant statute. If you put your own property into an LLC that you also own, sounds like that should not be a transfer — in fact, the relevant definition of transfer of ownership has a carve-out for transfers among commonly controlled entities. But fitting in that carve-out currently seems to depend on whether that property is used for business/trade activities or is residential, according to the rulings from the Michigan Tax Tribunal mentioned above and discussed below.
In the South Haven v. Scott case, the home had been in the same family for 80 years. At the relevant time, it was titled in an LLC wholly owned by Mrs. Scott. For estate planning and related purposes, the title was moved from the LLC to Mrs. Scott directly. The Tax Tribunal ruled that the common control carve-out has a business activity component and, thus, was inapplicable. The taxable value was uncapped, and property taxes popped up as a result of the transfer — even though the property’s underlying ownership and use did not change.
In contrast, the Lansing v. TRJ&E case involved the transfer of an apartment building by a corporation to an LLC. Three brothers owned 60 percent of the corporation and 75 percent of the LLC. The property had a business activity component, and the Tax Tribunal ruled that the overlapping ownership was sufficient to meet the common control carve-out. In fact, the Tribunal said that common control in these circumstances is met if the owners cumulatively control just over 50 percent in both entities, far less than required by long relied-upon guidelines published by the Michigan State Tax Commission and certainly less than the 100 percent overlapping ownership in the South Haven case.
The State Tax Commission has repeatedly issued “Transfer of Ownership Guidelines,” beginning in 2001 and most recently at the end of 2014. During the times relevant to these cases, the guidelines suggested that the cottage transfer in the South Haven case would not result in an uncapping, while the transfer of the apartment building in the Lansing case would. Both cases represent instances in which the Tribunal did not feel compelled to follow guidelines that have long served as the basis for planning real estate transactions in the context of property taxes.
This area clearly still is evolving. While the South Haven ruling is being appealed to the Michigan Court of Appeals and the Lansing case may be appealed, property owners would do well to keep them in mind if contemplating related party transfers to avoid potential negative tax consequences.
Loren Andrulis is a partner at the law firm Warner Norcross & Judd LLP where he concentrates his practice on transactional matters. He can be reached at firstname.lastname@example.org.