Potential Tax Hike for Ladybird Deeds and Life Estates

The Michigan State Tax Commission (Commission) recently issued its December 2014 Transfer of Ownership Guidelines, interpreting MCL 211.27a, which governs how real property is taxed. Most noteworthy were the guidelines addressing transfers of ownership of residential real property to certain close relatives (“qualified family members”) and transfers involving life estates. These new guidelines could be extremely problematic for certain individuals and families who have previously completed estate and/or cottage planning using deeds that retained a life estate interest in the owners, sometimes referred to as “ladybird deeds.”

In 2013 and 2014 the legislature added exemptions allowing real property owners to transfer residential property to qualified family members, identified in the statute, without having the taxable value of the property uncap and be reassessed based upon the current state equalized value (half the fair market value).

In efforts to take advantage of this new exclusion, and for several other reasons, many people conveyed their residential property to qualified family members or trusts, but retained life estates for themselves. This allowed the owner to avoid probate and uncapping, among other things, without having to lose control of the property. Before the new exclusion was available, it was a common strategy for avoiding probate when uncapping could not be avoided. As a result, many people have executed ladybird or similar deeds believing that, upon their deaths, the property’s taxable value will not uncap thanks to the new exclusion.

Unfortunately, what once was sound and accepted planning has now been called into question and could result in costly tax increases or litigation costs to defend. The Commission has all but said that it will uncap a property’s taxable value when a holder of a life estate dies, even if the deed passes the remainder interest in the property to a qualified family member.

The rationale of the Commission is not clear, but it appears that it has issued its new guidelines in a manner that provides at least two arguments in its favor. The strength and validity of the Commission’s likely arguments is highly debatable. Regardless, the reality is that until this matter gets resolved, the use of ladybird deeds or other life estate transactions will undoubtedly draw fire from the Commission and local assessors. As a result, it should only be used after you have had ample opportunity to weigh your options and consider the risk involved. If avoiding the uncapping of your property’s taxable value is important for you or your family, this is a good time to revisit your estate plan to ensure that you are taking advantage of the new opportunities provided by the state legislature, as well as to avoid any unintended consequences of prior planning resulting from this development.

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