August 2, 2023
Uncapping Rears its Ugly Head, Yet Again
Take-Away: Understanding Michigan’s uncapping rules for real property tax purposes is, to put it mildly, a frustrating exercise, where applying common sense and logic are a property owner’s worst enemy.
Background: We are all too familiar with the byzantine Michigan General Property Tax Act (for ease of reference, the Act) which is riddled like swiss cheese with exemptions and exceptions making it almost impossible to interpret with any confidence. All too often unsuspecting individuals who use common sense and logic transfer their real estate, only to later find that the taxable value of the real estate was uncapped, resulting in something of a legal ‘gotcha’ nightmare. Some important terms and concepts are used when the Act is both interpreted implemented by the taxing authorities.
Taxable Value: The taxable value of real property is capped, which means that the taxable value of the real property may only increase by 5% of the taxable value or the inflation rate, whichever is lower. [MCL 211.27a(2).] Thus, the result of capping is to keep real property taxes somewhat lower over an extended period of time, despite the impact of real market-based inflation.
Uncapped: When there is a transfer of ownership, the taxable value of real property becomes uncapped, the real property is then taxed at its state equalized value, which means generally 50% of the real property’s true cash value. [MCL 211.27a(3).] The uncapping of a property’s taxable value will cause its respective taxes owed to increase. Thus, the goal is to avoid a transfer that results in an uncapping of the taxable value of real property.
Transfer of Ownership: A transfer of ownership is the conveyance of title to, or a present interest in, the real property, including the beneficial use of the real property, the value of which is substantially equal to the value of the fee interest. [MCL 211.27a(6).] The Act lists several transactions with regard to property which are classified as transfers of ownership. These include the conveyance of an ownership interest in a corporation, partnership, sole proprietorship, LLC, or any other legal entity if the ownership interest conveyed is more than 50% of the entity. [MCL 211.27a(6)(h).] Thus, some transfers of an interest in an entity that owns real property might result in an uncapping.
Non-Transfers of Ownership: The Act also lists some transactions that are not to be treated as a transfer of ownership. One of these exceptions [shame on me, see below] which is highly relevant to estate planning is the transfer of property interests among family members. Specifically MCL 211.27a(7)(t) provides:
“Transfer of ownership does not include … beginning December 13, 2013 through December 30, 2014, a transfer of residential real property if the transferee is related to the transferor by blood or affinity to the first degree and the use of the residential real property does not change following the transfer.”
A recent Michigan Court of Appeals decision (unpublished) indicates just how literal the Act and its terms are interpreted by Michigan Courts, usually leading to the property owner feeling like he/she is the victim of a governmental ‘gotcha.’
Jeff Properties, LLC v City of Warren, Michigan Court of Appeals, Nos 362978 and 262979, (July 20, 2023)
Facts: In 2007 John and Mavis, husband and wife, transferred two residential rental properties to their limited liability company, Jeff Properties, LLC. In 2014 John and Mavis transferred all of their LLC units to their son, Junior. Apparently the assignment of Membership units was a gift to Junior (the court’s decision is silent on this point.) In 2021 Junior got around to completing and filing Property Transfer Affidavits with regard to the rentals. The City informed Junior that there had been a transfer of ownership under the Act, the taxable values of the two rental properties would be uncapped, and that taxes due on the rental properties would be increased.
Tax Tribunal: Junior challenged this uncapping at the Michigan Tax Tribunal. He claimed that the Assignment of the LLC units from his parents to him was a transfer from ‘parents to a child’, and thus the Assignment was a transfer between relatives by blood or affinity to the first degree and thus there was a non-transfer of ownership, and the rental properties should have remained capped. The Tax Tribunal found that there was a transfer of ownership such that the rental properties were subject to uncapping. Junior appealed to the Michigan Court of Appeals.
Court of Appeals: This Court affirmed the Tax Tribunal’s decision that there was a transfer of ownership and that the blood or affinity non-transfer exception [shame on me again!] did not apply. The Court found, as did the Tribunal, that the parents’ Assignment of Membership Interest in Jeff Properties, LLC was a transfer of ownership. [MCL 211.27a(6)(h).] That Assignment had the effect of conveying the 100% ownership interest in the LLC from the parents to their son.
No ‘Exceptions:’ Junior argued that there was a presumptive transfer of ownership because the transfer fell under the blood or affinity ‘exception’ of MCL 211.27a(7)(t). The Court disagreed that there are any ‘exceptions’ to the uncapping rules. Instead, the Court held that the ‘rule’ under MCL 211.27a(7)(t) provides that the blood or affinity condition is not a transfer. Accordingly “a transfer is either a transfer of ownership or it is not. As discussed, the transaction at issue- the assignment of membership interest in Jeff Properties ,LLC- was plainly a transfer of ownership and is therefore subject to the uncapping rules.”
LLC is Transferor: While the Court conceded that John and Mavis were parents of Junior, the blood or affinity condition did not mean that a transfer of ownership did not occur. “The parents conveyed Jeff Properties, LLC to Junior. In doing so, the parents conveyed the holding company that owned those properties. Because the conveyance of the two properties was a transfer of ownership in the context of the limited liability company, the transfer is subject to uncapping under subsection (6)(h) and the Tribunal did not err when it concluded as such.” In effect, the parents were ignored as the transferors, and attention was focused solely on the titleholder, the LLC, which was not a blood relative of Junior.
Comment: Anyone who has spent any time dealing with the Act and its uncapping traps understands just how confusing the law is and how easy it is to fall prey to those traps when logic is applied. Common sense is that the shortest distance between points is a straight line. But when navigating the Act, multiple ‘mini-steps’ or transfers, i.e., deeds, must be delivered and recorded when side-stepping the uncapping rules.
Example: Mom and Dad want to give their cottage to their daughter and her husband, who they view and treat as a son. A deed from Mom and Dad to daughter and husband will resulting in an uncapping since the son-in-law is not related by blood or affinity. A deed from Mom and Dad to daughter alone will not cause the taxable value of the cottage to be uncapped. After that deed, daughter can then add her husband’s name to the title and that second deed will not result in an uncapping, as transfers between spouses is one of those ‘non-transfers.’
Example: John and Mavis want to transfer their rental properties to their son Junior. If the rental properties are titled in the name of an LLC for liability protection purposes, we know that an assignment of the LLC units from John and Mavis to their son Junior will trigger and uncapping of the taxable values of the rental properties. If John and Mavis dissolve their LLC and they take back title to the rental properties in their individual names, and then John and Mavis then execute new deeds to the rental properties to their son Junior, the blood or affinity condition applies and it is treated as a non-transfer, and there is no uncapping. Junior, who also wants liability protection as a landlord, will then have to form a new LLC and transfer title to the rental properties to his own LLC. If Junior is married and he wants his spouse to participate in the LLC, then Junior must first add his spouse’s name to the title to the rentals, and then Junior and his spouse will then transfer their rental properties to their LLC.
There are ways to avoid the uncapping rules, but they often necessitate small steps, multiple deeds, multiple recording fees, etc., and most important of all, some forethought and patience as to how to get from A-to-B ‘the long way.’
Finally, to me the major problem with the Act (and its interpretation) is that most folks apply common sense and logic to their plans. They tend to follow that logic [getting from A to B in a straight line with the least amount of steps involved) only to learn that their linear logic led them to an unexpected uncapping event.
Conclusion: With Jeff Properties, LLC, we do not have an exception to the uncapping rules, per the Court. There are no exceptions. Rather we have a non-transfer of ownership, which leads to an uncapping when parents convey their interests in two rental properties to their son. “Gotcha Junior.”