Take-Away: Anyone who has had even a remote connection with Michigan’s real property tax transfer rules will readily conclude that those rules are frequently counter-intuitive  and which often lead to ‘gotcha’ results. Yet another reported decision of the Michigan Court of Appeals confirmed that many of the ‘uncapping’ taxable value rules are nonsensical  lay-in-wait traps for innocent real property owners.

Reported Decision: Puppy’s Cubby v City of Farmington Hills, No. 347757 (September 12, 2019) Unpublished

Facts: Oleg and Elizabeth Shvartsman purchased real property in 2007. Oleg and Elizabeth took title to the real estate as tenants by the entirety. From 2013 through 2017 Oleg and Elizabeth rented the real estate to third parties, i.e. the real estate was a profit making endeavor for them. In March of 2017, Oleg and Elizabeth conveyed title to the real estate by a quitclaim deed to a limited liability company (LLC). The LLC’s sole member was Oleg. In 2018, the local assessor uncapped the taxable value of the real estate because of the 2017 transfer of ownership, i.e. the transfer of title from Oleg and Elizabeth, by the entireties, to the LLC owned solely by Oleg.

Exemption Statute: A transfer of ownership of real estate in Michigan will result in an uncapping of the taxable value of the real estate unless an exemption applies. There are multiple exemptions in the statute, [the statute is often pejoratively described as ‘Swiss cheese’ legislation since it has as many holes as substance.’] The Michigan Tax Commission that writes the rules to guide tax assessors narrowly interprets those exemptions, or perhaps, as in this case refuses to provide helpful definitions.

The exemption that the LLC relied on provides that the uncapping provisions will not apply to a transfer of real property or other ownership interests: among corporations, partnerships, limited liability companies, limited liability partnerships, or other legal entities if the entities involved are commonly controlled. [MCL 211.271 (7) (m).]

Tax Court Proceedings: The LLC challenged the uncapping of the real estate’s taxable value in the Tax Tribunal based on the MCL 211.27a (7) (m) exemption.

Initially the Tax Tribunal judge assigned to the LLC’s challenge held that Oleg and Elizabeth were a partnership under Michigan’s partnership statute and the married couple, as tenants by the entireties, thus constituted a legal entity. Taking the next step, that judge found that Oleg’s continued interest in both the marital ‘partnership’ and the LLC satisfied the exemption, as both entities were commonly controlled. In short, Oleg initially won his challenge. But wait, there’s more to follow.

The City then asked the Tax Tribunal to reconsider the judge’s decision that there was no uncapping. The judge’s decision was assigned to a different Tax Tribunal judge for reconsideration, who found that the Shvartsmans could not legally be a partnership under the Michigan partnership statute since their rights as tenants by the entireties were controlled by another Michigan statute, one that exclusively addresses entireties ownership. [MCL 557.71] Therefore, the transfer of the real estate was not between two ‘legal entities’ and thus the transfer to the LLC did not meet the uncapping statute’s exemption. The LLC then asked the Tribunal to reconsider the second judge’s decision, which the Tribunal denied. The LLC then file its appeal with the Michigan Court of Appeals.

Court of Appeals: The Court of Appeals completely ducked the issue of whether Oleg and Elizabeth, as entireties owners, were a ‘legal entity’ under the exemption statute. Instead, the Court found that their transfer to the LLC was not between commonly controlled entities.

The Court acknowledge that the real property tax statute does not formally defined commonly controlled. In the absence of a formal definition supplied by the statute, the Court then looked to a ‘sister’ tax statute that defined under common control with as it relates to personal property tax exemptions. Using the other statute’s definition of control the Court found that since Oleg and Elizabeth owned the real property as tenants by the entireties, neither one of them controlled that real estate, so that while Oleg controlled the LLC, he did not control the real estate while it was owned by him with Elizabeth. Rather, Oleg and Elizabeth ‘shared control.’ Consequently, Oleg held some control, but apparently not enough control to satisfy the Court of Appeals and its common control standard.

A defining incident of this tenancy under Michigan law is that one tenant by the entirety has no interest separable from that of the other and has nothing to convey or mortgage or to which he alone can attach a lien….Stated differently, the consequences of a tenancy by the entirety ‘is that neither the husband nor the wife can dispose of the property without the assent of the other… Indeed, under MCL 557.71, ‘a husband and wife shall be equally entitied …to the control and management of real or personal property held by them as tenants by the entirety.’

Thus, the LLC loses its appeal, the real estate’s value is uncapped, and property taxes are increased that Oleg will have to pay as the LLC’s sole member.

Conclusion: The transfer of title from a married couple to an LLC owned by one of the spouses seems to be an innocent transaction, not designed to evade taxes but to provide a layer of liability protection.

One wonders if the outcome would have been different if Oleg and Elizabeth had owned the real estate as tenants in common, where each tenant was free to deal with his/her interest in the transferred real estate. Would the outcome be different if, however, as tenants in common, Oleg and Elizabeth had entered into separate a tenant-in-common agreement that restricted their transfer of their property interest without the consent of the other co-tenant, i.e. in which they abandon the unilateral control of their tenant-in-common interest?

Alternatively, what if Oleg and Elizabeth had taken title to the single LLC unit as tenants by the entireties, which is permitted under Michigan’s LLC statute? Since, per the Court, neither spouse controls an asset that is owned by the entireties, would that form of ownership also fail to satisfy the statute’s exemption and led to an uncapping if Oleg and Elizabeth, as tenants by the entireties had on the advice of legal counsel, transferred their real estate to an LLC where they owned the membership interest as tenants by the entireties?

Is there any wonder why so many property owners in Michigan are terrified anytime they transfer title to their real property that the transfer will produce a ‘surprise’ uncapping?