New Planning Tool of Choice for Michigan Cottage Succession

For several years, I’ve informed clients that forming a Limited Liability Company (LLC) was the preferred method in creating a cottage succession plan. LLCs provide an easy way for families to transfer ownership, manage and use the cottage, while also providing limited liability protection from potential third-party claims. However, now that the Michigan Legislature has modified certain aspects of the state’s rules on taxing real estate, including preventing reassessments of property being transferred among family members, planning with cottage trusts now should be considered as a planning tool in lieu of or addition to an LLC.

Changes to Property Tax Rules

Michigan law now allows parents to transfer real estate to their children, either during the parents’ lifetimes or at death, without uncapping or increasing the property’s taxable value. This  rule also applies to a “change in beneficial use” of a property titled in the name of a trust. Property can be transferred by parents to a trust during their lifetimes and then held in trust after the parents’ death for the benefit of their children, grandchildren and other future descendants. After the parents’ death, based on the children becoming beneficiaries, the transfer of benefit is characterized as a “change in beneficial use.” Under Michigan law, a change in beneficial use also does not uncap the property’s tae as a change in ownership from parents to children. As a result, when parents die, the cottage titled in the name of the trust may be used by the children, their children and grandchildren into the future without uncapping the property’s taxable value.

Unfortunately, the rules above do not apply to transfers of ownership interest for LLCs that hold title to family cottages. For an LLC, regardless of whether the transfers of ownership will be among family members, when accumulative transfer of ownership of more than 50% of the ownership of the LLC occurs, the property owned by the LLC is uncapped and assessed at most often what is a higher taxable value. As a result, the question that logically comes in to play is whether cottage planning should recognize the now more favorable tax advantages of using a trust versus an LLC.

So for those families that have previously created a cottage plan using an LLC or for those who are considering establishing a plan, the change in Michigan law which has now been in effect for a few years is a reason to revisit the concept of using a trust, instead of an LLC, to implement the cottage plan. There are ways to unwind previously established LLCs to reestablish essentially the same plan through the use of a trust should a family with an existing plan decide to do so. An example of this type of plan would be for a family to transfer ownership of the cottage from an LLC to its individual owners and then have the individual owners transfer the property to a trust that would include similar planning provisions to the LLC’s Operating Agreement.

The Need for a Plan

While the changes in the tax law favoring the taxpayers by now enabling the transfers of property from generation to generation without significant tax increases are significant, taxes are not the only consideration in developing a succession plan. As mentioned above, other equally important aspects of a cottage plan include factors such as how the cottage or property will be managed, how future expenses will be paid, how usage rules (i.e., who gets to use the cottage and when) will apply, and how a family member can cease being involved or exit as a participant in the cottage ownership. These other areas of planning significantly impact the success or failure of a family’s overall plan. There are multiple ways each of these areas can be addressed, and depending on the family’s goals and preferences, the planning for these areas may actually result in an LLC being a more preferred tool to implement the plan in spite of the possible sacrifice of the more tax-friendly treatment that planning with a cottage trust may provide.

There is no “one-size-fits-all” plan, and there is always more than one factor that should be considered in developing any cottage plan. Families should consider alternatives in their planning to possibly utilize a cottage trust as the planning tool given the change in the Michigan law, which now provides more favorable tax treatment to families passing ownership or beneficial use of a cottage within the context of a trust as opposed to the less favorable results concerning taxes for transfers of LLC ownership interests.