Client Alert March 26, 2024 Neil P. Jansen

Determining Whether to Keep the Family in the Family Cottage

Cottages and lake homes are enjoyed by thousands of families in Michigan.  Many owners may want to ensure that their children and grandchildren can continue to enjoy these special spaces.  However, there are many considerations to examine, including: unknowingly increasing the property taxes, determining control and management of the property, and avoiding conflicts among the new owners.

Common ownership is not easy.  As the number of owners increases, so does the difficulty.  So, before trying to address these concerns, you should determine if it is even necessary.  Does the next generation want to own the cottage and have the time and financial ability to do so.  Everyone enjoys using a cottage, but ownership can be expensive and entails hard work.  In many cases, passing on the cottage to the next generation may not be the best solution.  Today’s younger generations are mobile and family dynamics can change quickly.  Therefore, clear and proper communication with the children concerning responsibilities is essential.  Even if they do want to continue to own or have access to the cottage, there are several options to consider.

Especially if ownership has been long-term, preventing the property taxes from “uncapping,” which could unintentionally create unaffordable holding costs for heirs, is a significant concern.  During ownership, generally the taxes are capped at the rate of inflation not to exceed 5% (notwithstanding millage rate changes).  Uncapping of the ‘taxable value” occurs when property is sold, and this value is typically adjusted upward to the current year “assessed value.”  Thus, long term ownership typically indicates lower “capped” taxable values relative to the assessed values.  Fortunately, property tax uncapping is not an issue when passing the property to the next generation.  Under Michigan’s General Property Tax Act, transfers of residential property to certain close relatives, such as children, grandchildren, siblings, or parents, does not trigger uncapping.

Simply deeding the property over to the next generation, however, does not address potential conflicts among the parties and does not assure that proper management of the property will be carried out.  Many families look to one of the following three methods of transfer: a limited liability company (LLC), a co-tenancy agreement, or a trust.

While an LLC has advantages for cottage ownership, it has some notable disadvantages when transferring the property to heirs.  First, if the members of the LLC are the current owners, the property tax will not uncap, but once 50% of the members change, it will.  Second, cooperation among the heirs who become members can still create issues.  Finally, the original owners will lose the ability to easily change their mind should the family dynamics change, therefore making an LLC less desirable option.

Some families utilize joint ownership with their children by recording a deed that includes them and their children, along with a co-tenancy agreement that addresses how the property is to be managed going forward.  This will avoid uncapping and probate.  Nevertheless, there are still disadvantages with relying on a  co-tenancy agreement.  The original owners will lose control of the property and will now share ownership with their children.  Parents will lose the ability to have full control over how the property is managed and will instead need to work with their children to modify the agreement.  Thus, cooperation among the current owners and all beneficiaries can become an issue, particularly if children are in different financial situations.  Finally, should a child predecease a parent, that child’s children will likely no longer have an interest.  This makes a co-tenancy agreement a poor option as well.

This leaves one option remaining: a trust, which in this case, is the best option.  A cottage trust, when properly drafted, avoids uncapping of the property tax basis similar to a direct transfer to a child.  In a trust, however, the parents maintain control for as long as they wish, while still avoiding probate.  A trust delays issues with respect to cooperation among children, and allows the parents to create a document that will limit problems by spelling out future cottage management.  The parents’ ability to change their mind remains, and they can build in flexibility with respect to the children’s wishes to maintain the property.  For example, parents can provide funding for cottage maintenance in the trust for a temporary period.  Upon exhaustion of the funding, it becomes the burden of the children, who can choose to continue maintaining the property or sell it.

Deeding the property into a trust through a properly prepared “Ladybird Deed” may be advisable as it too does not trigger uncapping.  It provides all of the benefits noted previously with respect to trusts, but preserves greater flexibility for the owners because the property remains theirs during their lifetime and does not go into the trust until they pass.  Again, the need for cooperation among children is delayed, and the parents retain the ability to change their mind.  These options can also be tailored to determine a “buyout” value in the event a child or heir wants out of the ownership burden.  If the buyout value is not affordable to the other heirs, however, it commonly forces liquidation to a third-party buyer.

As described herein, there are many factors to consider when transferring property to the desired beneficiaries.  The first move is to find expert counsel to devise a plan that accomplishes the family’s ownership goals for everyone concerned.  By doing so, property owners increase the probability of ensuring that a dream is being passed on … instead of a nightmare.

Let’s start a partnership worth keeping.