• As the Legislature Giveth, the Taxman Taketh Away
  • April 27, 2015 | Author: Michael D. Shelton
  • Law Firm: Smith Haughey Rice & Roegge, P.C. - Grand Rapids Office
  • The Michigan State Tax Commission (Commission) recently issued its December 2014 Transfer of Ownership Guidelines interpreting MCL 211.27a, which governs how real property is taxed. Most noteworthy were the guidelines addressing transfers of ownership to certain close relatives and especially transfers involving life estates. These new guidelines could be extremely problematic for certain individuals and families who have previously completed estate and/or cottage planning using deeds that retained a life estate interest in the owners, sometimes referred to as “ladybird deeds.”

    In the state of Michigan, when you buy a home the local tax assessor determines the fair market value (FMV) of your home. Half of the FMV is known as the state equalized value (SEV), and it establishes the taxable value of your property in the year following your purchase. The law protects you from overly burdensome and unanticipated property taxes by “capping” the rate at which the taxable value of your property increases each year. As a result, even if the FMV and SEV of your property doubled in following years, your taxable value would not increase faster than the rate of inflation or five percent. Instead, the taxable value of the property would be significantly lower than the SEV. However, as soon as there is a transfer of ownership, the local tax assessor will redetermine the FMV and the new property owner will owe taxes based on the now higher SEV, which will once again be equal to the taxable value. This process is called “uncapping.” In some instances, that new owner may be you, your spouse, your children or other close family members.

    In 2013 the Michigan Legislature amended MCL 211.27a with the intention of making it easier for property owners to pass their residential real property to certain family members without uncapping the taxable value of that property. The statute simply read that “a transfer of ownership does not include... Beginning December 31, 2013 a transfer of residential real property if the transferee is related to the transferor by blood or affinity to the 1st degree and the use of the property does not change following the transfer.” The Commission took the position that this exemption did not prevent uncapping when the transfer of ownership occurred through an owner’s probate estate or through his or her trust, even if the heirs and beneficiaries receiving the property were related to the owner within the 1st degree.

    In the middle of 2014 the Michigan Legislature amended the statute to state that, beginning December 31, 2014, transfers of residential property that are not used for commercial purposes will not cause a property’s taxable value to uncap if it is transferred to a parent, child, adopted child, stepchild, or grandchild of the owner or the owner’s spouse, even if the transfer occurs through an estate or trust (qualified family member).

    Now, less than a month before the new amendment takes effect, the Commission has issued guidance that once again seems to disrupt the Legislature’s intent. It agrees that a landowner can give or sell property to those certain specified family members by deed, through a trust, or through a deceased owner’s estate, with or without a will, and that the taxable value will not uncap. The problem now arises when you try to convey residential property to a qualified family member in a manner that involves a life estate. Before the qualified family member exemption existed, the law allowed an owner to convey property to another person but retain a life estate in the original owner for his or her own use and interest. So long as the original owner had the beneficial use of the property during life, the property’s taxable value would not uncap. A transfer of ownership occurred immediately upon the termination of the life estate, when the beneficial interest changed from the original owner to the new owner, and the taxable value would uncap. It did not matter who the property transferred to because there was no family member exclusion before 2014.

    Assume that Husband A and Wife B have owned their home for 60 years. The FMV of their home in 2014 is $500,000, making the SEV is $250,000. Because the property has not been transferred for 60 years, the taxable value has not uncapped, and A and B are currently paying taxes as if the house were valued at $100,000. A and B would like to leave their house to Son C, who will not likely be able to afford the taxes on a $500,000 house. In January 2014 they learned of a new exemption to the uncapping statute that would allow them to transfer their house to C without uncapping the property’s taxable value. Because the Commission did not believe the exemption applied to property that transferred to C through their probate estate or through a trust, and because they did not want to give their house away while they were still alive, A and B decided to execute a ladybird deed. With a ladybird deed, A and B transferred a life estate to themselves and also retained the unrestricted right to sell, convey, lease, mortgage, or otherwise manage or dispose of the property as they saw fit during their lives, but immediately upon their death, without going through probate or trust, the property passed to C.

    Because it would not be passing through the estate or trust, and because it passed to their son (a qualified family member), it was widely believed that a commonsense reading of the statute would allow the property to be transferred to the son without the taxable value uncapping. This was a fairly common method of transferring property prior to the new guidance by the Commissioner.

    However, the Commission added new language to its December 2014 guidance which had not existed in the April 2014 guidelines. The Commission now believes that if two provisions of the statute conflict with each other, one allowing an exemption and one disallowing an exemption from uncapping, then the provision that is the most specific will apply. The Commission seems to believe that where there is a conveyance of property in which the owner retains a life estate, a transfer of ownership occurs and uncaps the taxable value at the termination of the life estate. It does not matter that a qualified family member is the recipient. The position that if the life estate exclusion applies it controls the transaction is contrary to prior guidance issued by the Commission, which stated that uncapping would occur when the life estate terminated unless another exclusion applied.

    Regardless of the validity of the Commission’s position, the reality is that until this matter gets resolved, the use of ladybird deeds or other life estate transactions will undoubtedly draw fire from the Commission and local assessors. As a result, it should only be used after you have had ample opportunity to weigh your options and consider the risks involved. If avoiding the uncapping of your property’s taxable value is important for you or your family, this could be a good time to revisit your estate plan to ensure that you are taking advantage of the new opportunities provided by the state legislature as well as to avoid any unintended consequences of prior planning that could arise from the Commission’s new guidance.