The Practical Effect of Michigan Supreme Court’s Decision in the case of Klooster v City of Charlevoix
The Supreme Court’s decision in the Klooster case provides that certain types of joint ownership of real estate in Michigan can prevent property taxes increasing at the time of a joint owner’s death. While the decision is generally favorable to the taxpayer, there are various rules and contingencies that must be satisfied in order to achieve property tax savings.
Historical Perspective on Michigan’s Property Tax System
In 1994, voters passed a law (Proposal A) amending a portion of the Michigan Constitution to limit the annual increase in property tax assessments. The purpose of the law was to limit taxes on property as long as it remained owned by the same party, even though the actual market value of the property may have risen at a greater rate. The Michigan Legislature was then instructed to determine the specific rules needed to implement the effect of the law on Michigan property taxes.
The Legislature passed law that fixed the cap on assessment increases at the lesser amount of either 5% of the assessed value of the property for the previous year or the increase in the rate of inflation from the previous year (usually less than 2%). However, after certain transfers of ownership occur, property becomes uncapped and thus subject to reassessment based on actual property value. In the event of a “transfer of ownership” of property after new law took effect in 1995, the property’s taxable value for each calendar year following the year of the transfer is the property’s state equalized valuation for the calendar year following the transfer.
From the definition of “transfer of ownership” set forth by the Legislature in the law, there were 17 specific transfers and conveyances that were exemptions (exceptions), including the creation and termination of certain joint tenancies (transfers creating a joint ownership of property or the death of a joint owner). In the event an exemption applies, the property does not become uncapped and is not then subject to reassessment based on actual property value.
The Joint Tenancy Exemption
In order to avoid an uncapping of property taxes at the death of a joint owner, the first element that must be satisfied is that when the joint ownership was established, at least one of the joint owners was an “original owner”. An “original owner” to satisfy this provision of the joint tenancy exception would be a person who owned the property at the time that the last “uncapping occurrence” occurred. For example, if a husband and wife, or the survivor of them, purchased property in 1998 resulting in the uncapping of the property at the time of their purchase, then either of them would be an “original owner” and satisfy this element of the joint tenancy exception.
The next element that must be satisfied in order for the joint tenancy exception to apply is the form of joint ownership must be “joint ownership with rights of survivorship.” This type of joint ownership means that all of the joint owners have a current ownership interest in the property; however, at the time of one of their deaths, the deceased individual’s interest then, by operation of law, transfers to the remaining joint owner(s). A type of joint ownership that does not satisfy the test is joint owners as “tenants in common”. This type of joint ownership indicates that a joint owner and undivided fractional share of the property and in the event of a joint owner as a tenant in common’s death, the deceased individual’s share is then part of his or her estate and can transfer to their heirs.
As a result, a parent who is an “original owner” pursuant to the aforementioned definition can now transfer real estate to his or her children as joint tenants with rights of survivorship. In the event the parent predeceases the children, there would be no uncapping of the property for property tax purposes at the time of the parent’s death. Neither the initial transfer by the parent to the children or the subsequent death of the parent would constitute a “transfer of ownership” and result in an uncapping of the property for property tax purposes. This scenario can be attractive to certain real estate owners who wish to transfer their property to their children without a significant increase in the property taxes resulting at the parent’s death.
The potential problem with creating joint tenancies to avoid an increase in property taxes is that the time of the death of an original owner, the surviving owner must maintain joint ownership of the property as “joint tenants with rights of survivorship”. A requirement of continuing to own the property as joint tenants with rights of survivorship means that if ownership is maintained that way, then at the death of one child, the remaining children would receive that deceased child’s ownership share. That result is not usually keeping with parent’s goal that children often times be treated equally with respect to the assets in the parents’ estate. The solution, in order to achieve the parents’ intended goal would be to change the ownership of the property after the parents’ death from joint tenants with rights of survivorship to joint tenants as tenants in common. However, that change of ownership would be deemed to be a transfer of ownership and the property would uncap for property tax purposes at that time.
As a result, the joint ownership exception for purposes of avoiding an uncapping of the property at one joint owner’s death is most attractive where a parent(s) intends to leave ownership of real estate to a single child. That being said, there is an advantage to transferring property jointly to more than one child in that the children can always own the property for an indefinite period of time before changing ownership to “joint ownership as tenants in common” which would uncap the property but, in the mean time, children as joint owners would enjoy the tax savings.
While the Supreme Court’s decision presents a benefit to Michigan taxpayers who are real estate owners, everyone should keep in mind that the Legislature could amend the current law to remove the joint ownership exception which has been recognized by the Supreme Court in the Klooster case. Whether or not legislative action in the future would be retroactively applied to those joint ownership situations that existed prior to any legislative action taking place is unclear. If you are considering a transfer of real estate to possibly take advantage of the joint tenancy exemption, please contact us to discuss the specific facts of your situation and your goals to make sure your proposed action is best for you and your family.
Dan A. Penning