Passing Down the Family Cottage

Presented By:

John R. Blakeslee, Stephen C. Chambers, Kevin M. Huss & Robert W. Parker, Attorneys

Assess Situation

• Do the current owners intend for the cottage to be passed to the next generation?

• Are members of the next generation interested in taking over the cottage?

• What is the cost to maintain the cottage on an annual basis?

Common Goals

• Pass down cottage to future generation(s) • Minimize tax consequences • Provide clear requirements for contributions and permitted uses • Minimize exposure to risks associated with use • Provide flexibility for future generation(s) • Maintain the family dynamic

To Plan

• Begin considering the following questions: – Children’s income or financial condition – Proximity and usage – Upkeep – Taxable value – SEV – Use of the cottage by spouse, grandchildren – Seasonal and off-season use

To Plan, cont.

– Pets – Smoking – Rules – Penalties – Who opens/closes the cottage – Do-It-Yourself vs. hired maintenance – Other assets, such as boats, ATVs, etc.

– Third party renting

Not to Plan

• Taxable value of property will be uncapped when passed to heirs from estate or trust • “New” owners will be left to determine issues such as: – Payment of taxes – Use of cottage – Payment of maintenance costs – Resolution of conflicts among themselves

Not to Plan, cont.

• Often results in one of the following: – Lawsuit among owners – Forced sale to a third party – One owner buying out others – Strained family relationships

Property Tax Uncapping

• Michigan law provides that, in general, a property’s taxable value is “capped,” meaning that it cannot increase more than 5% from year to year.

• However, when a “transfer of ownership” occurs, the taxable value is automatically “uncapped” and increased to approximately 50% of the market value of the property.

New Exemption

• Beginning in 2014, a new exemption from uncapping for interfamily transfers was created.

• However, at the present time, this exemption does not extend to transfers from probate estates or trusts.

• Transfers to and from entities may also be subject to uncapping.

Solution 1: Outright Transfer to Next Generation

• This method may work when: – The taxable value of the property is close to half of its market value – The current owners no longer wish to be involved in or responsible for management of the property – The current owners are able to bear the potential gift tax associated with this transfer

Solution 1: Outright Transfer to Next Generation, cont.

• Potential drawbacks: – No mechanism in place to resolve conflicts among new owners, absent some additional work – Cottage may be subject to creditors of new owners or to spouses in the event of divorce – New owners are left to address issues relating to pets, maintenance, rental, etc.

Solution 2: Lady Bird Deed

• This solution may work when: – Current owners want to retain property and pass to next generation at death – Current owners wish to avoid cottage being included in probate estate

Solution 2: Lady Bird Deed, cont.

• Potential drawbacks: – May not avoid uncapping due to uncertainty in the law – No mechanism in place to resolve conflicts among new owners, absent some additional work – New owners are left to address issues relating to pets, maintenance, rental, etc.

– Cottage may be subject to creditors of new owners / former spouses in divorce after death of original owners

Solution 3: Joint Ownership

• This solution may work for: – Owners want a simple structure to avoid probate and pass to next generation – Owners wish to avoid the uncapping of taxable value associated with an outright transfer of ownership

Solution 3: Joint Ownership, cont.

• Potential drawbacks: – Depending on type of joint ownership, there may be no mechanism in place to resolve conflicts among owners after death – New owners are left to address issues relating to pets, maintenance, rental, etc.

– Cottage may be subject to creditors of new owners / former spouses in divorce after death of original owners – Depending on the type of joint ownership, one of the new owners may end up taking all to exclusion of others as second generation passes away

Solution 4: Trust Ownership

• This solution may work when: – Original owners wish to identify rules and regulations for control of property – Future owners wish to take advantage of potential income tax benefits upon death of original owners – Can have certain advantages for individuals who expect to pay estate tax upon death

Solution 4: Trust Ownership, cont.

• Potential drawbacks: – Trust becomes inflexible and hard to change upon death of person creating trust – Failure to address all potential issues in trust sets up potential for conflict among trust beneficiaries – Under current law, property taxes may uncap upon death of original owner

Solution 5: Entity Ownership

• This solution may work for: – Owners wish to have a structure in place for addressing common issues associated with cottage – Owners wish to provide some protection from creditors / divorce of future owners – Owners wish to provide enough flexibility in ownership structure to account for unforeseen changes – Owners wish to gift percentage of ownership to future generations over time

Solution 5: Entity Ownership, cont.

• Potential drawbacks: – Taxable value of property can uncap if done improperly or transferred in the future – Original owner may lose control over cottage as interest is gifted to next generation – No principal residence exemption is available

Takeaways

• Plan early, and have conversations with family to determine: – Who, if anyone, may be interested in owning the cottage in the future – Who can bear the burdens of cottage ownership • Assemble a team of advisors to assist in planning: – Attorney – CPA – Financial Planner

Takeaways

• Determine the true annual cost of ownership of the cottage, including: – Insurance – Taxes – Association dues – Maintenance/repairs/replacements • Are the members of the next generation going to be able to cover these expenses, or is a separate fund going to be necessary to provide funding • Review the cottage plan with your existing estate plan to make sure it is consistent

Questions?

John R. Blakeslee | 231-486-4555 | [email protected]

Stephen C. Chambers | 231-486-4546 | [email protected]

Kevin M. Huss | 231-724-3214 | [email protected]

Robert W. Parker | 231-486-4504 | [email protected]