Guest Column

Transferring the family cottage may be tougher in 2019

February 22, 2019
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Thanks to a recent decision by the Michigan Court of Appeals, transferring your family cottage into a limited liability company could increase your property taxes significantly. The decision came in the case of Scott v. South Haven, which was decided by the Michigan Court of Appeals in April 2018. And just last month, the Michigan Supreme Court decided not to review the Scott decision, which means the Court of Appeals decision is final.

To understand how the Scott decision might affect your property taxes, we need to first understand how the taxable value of property is calculated. In Michigan, the taxable value of a property can generally only be increased each year by the rate of inflation or 5 percent, whichever is less, unless a “transfer of ownership” occurs.

If there is a transfer in ownership, then the taxable value is “uncapped,” which means it is increased to the state equalized value, or SEV. The SEV is based on the state’s appraisal of the fair market value of the property.

In the past several years, inflation has consistently been below 3 percent, which means that property taxes have increased rather slowly when compared to fair market value, and, thus, the SEV of the underlying property. This can create large discrepancies between the taxable value and the SEV of a given property.

This is exactly the scenario facing many families who have owned certain properties, such as a cottage, for long periods. This means the family could be paying rather low property taxes for a property whose fair market and SEV have increased significantly.

Transfers, common control

It has been a somewhat common practice in Michigan for families to transfer their cottages to LLCs. This can provide certain protections from liability while also allowing the property to be efficiently managed and passed down to future generations.

Previously, a family who owned a cottage appeared to have the ability to transfer it into an LLC without the risk of uncapping the taxable value, so long as the same individual or individuals who owned the property also owned the LLC in the same percentages. Michigan law does not consider a transfer of property between two entities “under common control” to be a transfer in ownership which results in uncapping.

The State Tax Commission’s Transfer of Ownership Guidelines previously stated that transfers between individuals and entities owned by those same individuals were not considered transfers of ownership. So if a husband and wife transferred their cottage to an LLC owned solely by the same husband and wife, a transfer of ownership would not have occurred, and the taxable value would not be uncapped.

Scott v. South Haven

The case of Scott v. South Haven has changed all that. In 2017, the tax tribunal decided that the transfer of a cottage from Joan Scott to an LLC owned solely by Scott was indeed a transfer of ownership because it was not a transfer between entities “under common control.” The taxable value of the cottage was uncapped at the time of transfer.

In April 2018, the Court of Appeals affirmed that decision. The Court of Appeals agreed with the tax tribunal that in order to qualify as a transfer between entities under common control and prevent uncapping, the entities must engage in certain business activity.

Because Scott owned the cottage for her personal use and did not engage in any business activities with regard to the cottage, the court decided that the transfer from Scott to the LLC was not a transfer between entities under common control since Scott was not an “entity” for purposes of Michigan law.

After the Court of Appeals’ decision, the Scotts tried to appeal the case to the Michigan Supreme Court. However, the Michigan Supreme Court recently declined to review the case, which means that the decision from the Court of Appeals is here to stay, at least for now.

The takeaway

Under the precedent in Scott v. South Haven, if you want to transfer a family cottage to an LLC you will risk uncapping the taxable value. Depending on the difference between the cottage’s current taxable value and its SEV, such an uncapping could lead to a significant increase in property taxes. You should carefully analyze the potential tax increase and whether such an increase is a worthwhile tradeoff.

M. Johnny Pinjuv is an attorney with Warner Norcross + Judd LLP who focuses his practice on business and real estate issues. He can be reached at mpinjuv@wnj.com.

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