Re-thinking property tax planning
Benjamin Franklin is famous for saying, “In this world, nothing can be said to be certain, except death and taxes.” Despite their inevitability, many people still strive to eliminate or reduce their tax burdens.
Property taxes in Michigan are rising to the forefront of tax planning due to a confluence of factors:
- Increasing property values
- Legislative changes
- Changing administrative interpretation of legislative changes
Increasing property values is good news, but it produces some estate planning complexity. The genesis of property taxes as a planning issue is 1994’s Proposal A. Property taxes in Michigan are assessed on the “taxable value” of a parcel. With the adoption of Proposal A, annual increases in a parcel’s taxable value have been capped to the lesser of the rate of inflation, or 5 percent, meaning that throughout their ownership, a property owner will see a maximum increase in their taxable value of 5 percent per year.
Local assessors also annually assess a parcel’s State Equalized Value, which is equal to one-half of a property’s true cash value. In an environment of rising property values, property owners will see an ever-widening gap between their taxable value (lower) and SEV (higher).
When there is a transfer of a parcel, the parcel’s SEV is substituted for its taxable value in the year following the transfer (i.e., the value of the property is “uncapped”). When real estate has appreciated, uncapping results in a much higher taxable value and, consequently for the new owner, much higher taxes. However, the legislature has exempted certain transfers from uncapping by declaring that such transfers are not “transfers of ownership” for the purposes of the General Property Tax Act. Therefore, when dealing with real estate assets as part of an estate, consideration must be given to how transfers of the real estate will cause an uncapping either now or in the future and whether uncapping can be avoided.
The most prominent recent legislative change with regard to this issue is the exemption from uncapping for intra-family transfers. Without diving too far into the evolving particulars, property owners may now deed residential property to immediate family members (i.e., children, parents, in-laws and step relations) provided the “residential real property is not used for any commercial purpose following the conveyance.” For property owners wishing to pass residential properties such as family cottages to their children, this new exemption opened up a viable new estate planning option.
The intra-family uncapping exemption is a positive legislative change. However, the administrative interpretation of pre-existing uncapping exemptions, presented to the public via the Michigan State Tax Commission’s “Transfer of Ownership Guidelines,” has seemingly contracted in response to that expansion.
Of particular concern in the latest iteration of the guidelines is the treatment of “ladybird” deeds. With a ladybird deed, the owner retains full rights to the property during his or her lifetime (including the right to sell), and names beneficiaries to receive the property on his or her death. Ladybird deeds are attractive for many reasons: the owner retains the benefits of the property while avoiding issues such as the complexity of joint ownership and probate of the property at the owner’s death. Prior editions of the guidelines were interpreted as expressly permitting ladybird deeds as an uncapping avoidance mechanism. In July 2014, references to ladybird deeds were omitted and the latest version of the guidelines includes the following example:
In 2013 Sandy Smith owns property and conveys the property to her son, Noah, retaining a life estate over the entire parcel. Sandy dies in 2014 and the life estate is terminated. Does the death of Sandy Smith result in a transfer of ownership?
Yes. A transfer of ownership occurs upon the death of Sandy Smith since her death terminated the life estate. No other exceptions or exemptions apply.
This interpretation is surprising, but not unexpected. For years, assessors, attorneys and clients have wrestled with how certain uncapping exemptions interact with one another. Just as with the application of the “commonly controlled entity” exemption from uncapping, the STC is unable to reconcile, in a logical manner, a situation like the above where an uncapping exemption (intra-family) intersects with an explicit transfer of ownership (termination of life estate).
Although the prudence of employing some historically reliable estate planning techniques like ladybird deeds are now questionable, you can be certain that you should seek informed guidance on an ongoing basis with respect to your estate planning needs generally and real estate dispositions specifically.