Corporate Real Estate, Scott Breen

Transferring Real Estate to Your Children Without Tax Penalities

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A Michigan law was recently enacted which will allow parents to transfer real estate to their children without certain property tax increases.  Although the substance of this law will not go into effect until December 31, 2013, it is important to keep this law in mind when considering your estate plan.

I recently published an article titled Jointly Owned Real Estate: New Planning Options. That article outlined certain planning techniques involving jointly owned property, which related to the same general concerns of passing property to the next generation without creating large property tax increases.  If you read that article, the principles in the next section will sound familiar but it is worth revisiting them.

The “Uncapping” Problem

The transfer of real estate often causes an increase in the amount of property taxes that the recipient will have to pay in the future.  In order to understand the problem, it must be understood that real estate has a “state equalized value (SEV)” and a “taxable value.”  The state equalized value represents one-half of the fair market value of the property as determined by the local assessor.  The taxable value is the amount that is subject to property taxes.  In the year after you acquire real estate, the SEV and taxable value are the same.  In determining your property taxes, municipalities multiply the taxable value (not the SEV) of your property by the millage rate.  Michigan law limits the yearly increase of the taxable value of real estate (not the SEV) to the rate of inflation or 5%, whichever is less.  Since the SEV is always based on fair market value, the SEV often increases more than the taxable value.

Generally, the longer that real estate is owned, the greater the gap between the SEV and the taxable value (since property values have generally increased over time).  Upon a “transfer of ownership” (as defined by Michigan law), the taxable value is adjusted upward to equal the SEV.  This is commonly called “uncapping” of the taxable value.  This property transfer and the resulting “uncapping” can greatly increase the amount of property taxes that will be owed.

Tax Relief

Historically, a transfer of real estate from a parent to a child was considered a “transfer of ownership” that uncapped the taxable value of the real estate.  That often caused large increases in the property taxes that a child would have to pay.

Beginning on December 31, 2013, there will be no uncapping of the taxable value of real estate if: (1) a parent transfers residential real estate to a child (or from a child to the parent); and (2) the use of the property does not change following the transfer.  This law allows parents to transfer property characterized as “homestead” property as well as other types of residential property such as cottages.  The child would have to use the property in the same manner as the parents.  In other words, the child could not lease the residential property or establish a commercial enterprise (presuming the parents were not doing so).

There is one major problem with the new law.  It is currently unclear whether the law allows a personal representative of the parent’s estate (or a successor trustee of the parent’s trust) to transfer the property to the child after the death of the parent.  Tax practitioners are attempting to get clarification on this issue through an amendment to the law.  This uncertainty makes estate planning even more essential because there are other planning techniques that may be used to address these concerns.

If you own real estate and intend on transferring it to your children (either before or after death), it would be wise to take another look at your estate plan.  If you would like to discuss your situation in more detail, you may contact Scott A. Breen at 517-324-1021 or