As if passing a family cottage from one generation to the next isn’t emotionally and financially tricky enough, Michigan’s tax laws keep evolving, sometimes leaving families scrambling to reshape the carefully thought-out transition plans they’d just written (legal fees noted).
Such is the case this year for families that chose to manage a family cottage through a limited liability corporation. A change in state tax law prevented LLCs from having access to an important inheritance tax provision that allowed families to pass cottages to successive generations without increasing the property tax rate. Dan Penning, a cottage law attorney, helps us understand the situation and explains what families with LLC cottage plans can do in response—and how LLCs can still be an effective part of the strategy.
Give us a flyover of the situation cottage LLC families find themselves in.
“A Michigan tax law change that went into effect on December 31, 2014, allowed certain family members including parents, to pass property to their children without uncapping the property tax. That is, the property would continue to be taxed at the rate the parents had been paying, which could be based on the property value of decades ago. But the tax law change did not allow LLCs to take advantage of that change, so when the parents came to hold less than 50 percent of the LLC, the property tax would be uncapped, meaning the property would be re-evaluated at today’s real estate rates and the tax could increase significantly.”
So, were all of those families who had chosen to manage their cottage inheritance through LLCs left in the lurch?
“Yes, it seemed to present families with a really unfortunate choice: Have a great plan and no tax advantage or have a great tax advantage and no plan.”
What is the path to the “and” solution, not the “or” solution for cottage LLCs?
“Yes, well, it was an intellectual challenge to figure what we could do to capture the best of both worlds. The new law forced us to resurrect an old tool, the trust, which historically was how many families handled cottage ownership. The trust has continuous ownership of the cottage, so the taxes are not uncapped through successive generations. But trusts are not ideal to use for creating a plan to manage a cottage.”
“For one thing, if the trust owns the cottage, the individuals are not able to deduct property taxes. Also, family groups tend to want a more democratic process for making decisions, but a trust tends to be more autocratic, with fewer people managing.”
Where does the LLC come into play?
“You marry up the LLC and the trust. When the parents pass, the trustee of the trust enters into an administrative agreement with the LLC, which is where the operating agreement resides—things like how expenses will be handled, how management decisions will be made, rules about use. So the trust assigns administration of the cottage to the LLC. And the ownership percentages of the LLC match the ownership percentages of the trust.”
That sounds complicated.
“Retooling the plan is not as bad as you’d think. You are just taking legal title out of the LLC, and the operating agreement for the LLC is already in place. It’s really only a few changes to make the LLC sync up with the trust. You are not doing the whole thing over, so from cost standpoint, it’s much less than the original plan.”
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