Property Tax Uncapping, Part 1 of 3: First, Some History

Since the introduction of the Headley amendment (Proposition A) to Michigan’s property tax laws, the property tax assessment has been divided into a Taxable Value (TV) and a State Equalized Value (SEV). The TV is what taxes are actually based upon. The TV may not increase by greater than the COLI or 5% whichever is less.

The SEV is the tax assessor’s opinion as to one-half of fair market value, and there is no limit on the amount this can increase in a given year. Over time, for some properties, a large gap has developed between the TV and the SEV.

Whenever property changes hands, whether from a sale, or a death/inheritance, or a gift, the general rule is that the property’s TV will be adjusted so that it equals the SEV. This process is called “uncapping.” Because there are some properties with a 200% to 400% difference between the TV and the SEV, many people face the challenge of figuring out a way to transfer the family cottage/home/farm to the next generation without causing a huge increase in the property taxes.

Thus, for some families, the prospect of inheriting the family cottage is fraught with anxiety over whether the children will be able to afford the property taxes. Granted, for real property that was acquired after the housing plunge in the late 2000s, this issue often does not arise, because the relative depression of the market in the years since has resulted in TVs and SEVs that are very close if not nearly identical. But when this issue does arise, rest assured that there are several options at your disposal.

The Changes Brought on by Klooster v. Charlevoix

In 2011, the Michigan Supreme Court decided in Klooster v Charlevoix, 477 Mich. 289 (2011), that a transfer of real estate from a parent to a child did not cause the property tax assessment to uncap if the parent first made the child a joint owner with rights of survivorship in the property, and then subsequently transferred ownership to the child by death or deed.

However, Klooster did not directly address a transfer of property to multiple children. The Klooster decision only specifically addressed the situation in which a joint tenancy terminates because one joint tenant (the original) dies, leaving the other joint tenant (the new) with sole ownership of the property.

In response to Klooster, the State Tax Commission (STC) revised its Transfer of Ownership Guidelines (the “Guidelines”) with the intent of presenting several scenarios to explain its interpretation of Klooster. As a side note, it is important to know that while the STC does not have law-making authority, it is the agency that directs the actions of all of the local tax assessors. Therefore, as a practical matter, unless a person is willing to challenge the rulings of the local tax assessor, in most cases, what the STC says is how the law will be applied. Returning to the point, the August 2011 revisions to the Guidelines also did not cover what happens when a parent transfers real property to more than one child.

Fortunately, the STC’s March 2012 revisions to the Guidelines finally clarified the STC’s interpretation of Klooster. Unfortunately, that clarification stated that if the fact situation did not mirror exactly the facts of Klooster, the STC would find that the tax assessment was uncapped. Thus, a transfer from a parent to more than one child as joint tenants with full rights of survivorship would cause the uncapping of the property upon the death of the parent.

To say the least, this caused a bit of consternation in the estate planning community, as many of us had assumed that Klooster would allow parents to create joint tenancies with more than one child at a time, which is what most families would have wanted to do. However, changes were made to our approach and we began to utilize the “Klooster Method” (as we began to refer to it) with just one child so that we would not run afoul of the STC’s guidance.

To be continued …

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