Pulling the Cap Off of Uncapping Events in Michigan: Understanding Proposal A and Avoiding Costly Mistakes When Transferring Real Estate

By Andrew M. Harris

Michiganders are fortunate to live in a state where the law limits — or “caps” — how much the taxable value of their real estate can increase every year. But that limit — 5% or the inflation rate, whichever is lower — goes by the wayside upon a “transfer of ownership” of the property. When that occurs, the property’s value is “uncapped,” and the property is taxed at its state-equalized value, which is generally 50% of the property’s true cash value. That’s a substantial difference. 

Passed in 1994, Proposal A is the law that established the cap and set forth the events that uncap a property’s taxable value. But Proposal A is full of nuance and complexities which can easily lead to costly mistakes.

In this article, we discuss how to identify uncapping events under Proposal A, the difference between an “addition” and an uncapping event, and how to avoid accidentally sending your property’s taxable value through the roof.

What Proposal A Did to Michigan’s Property Tax Regime

Proposal A amended Michigan’s Constitution to address both school funding inequities and high property tax burdens. It impacted the state’s property tax regime in two fundamental ways:

• It limited growth on the taxable value of individual parcels of property to the LESSER of the inflation rate or 5%, and
• Upon the SALE or TRANSFER of a property, its taxable value resets to the State Equalized Value (“SEV”), which equals one-half of the property’s fair market value.

“Taxable value” means the value of a parcel of real property, considering the protections of Proposal A. Here are two examples reflecting how taxable value is calculated and its impact on property tax amounts, 

• Example A: If a property is worth $500,000 according to the taxing authority, the SEV is $250,000. Accordingly, if the total mills on a property are 50 mills (1 mill for every $1K of value), property taxes are $12,500.
• Example B: In 2022, Dan Campbell purchases a property worth $1,000,000. For the 2023 tax year, the SEV and taxable value will be the same. With a 50-mill tax rate, taxes owed for 2023 will be $25,000. In 2023, the property’s value goes up 10% to $1,100,000. The SEV is now $550,000, which would trigger taxes of $27,500, but Proposal A (barring a transfer or addition) requires taxation at the taxable value. If the inflation rate was 3%, then the taxable value is $500,000 x 1.03, or $515,000, eliciting taxes of $25,750 (a savings of $1,250). As the years go by, the benefits of Proposal A continue to grow.

The Effect of “Additions” on Taxable Value Under Proposal A

Proposal A codified the taxable value of each parcel of property as the lesser of:

• The property’s taxable value in the immediately preceding year minus any losses, multiplied by the lesser of 1.05 or the inflation rate, plus all additions.
• The property’s current state equalized valuation.

Under Michigan law, an “addition” is an “increase in value caused by new construction…a physical addition of equipment or furnishings…” For example, let’s say Coach Campbell’s home undergoes a small renovation, increasing the property’s value by $20,000 in 2023. The taxable value is not the aforementioned $515,000; it is now $515,000 + the addition ($20,000), making the taxable value = $535,000.

Identifying (and Avoiding) Uncapping Events

Upon a “transfer of ownership” of property after 1994, the property’s taxable value for the calendar year following the year of the transfer is the property’s SEV for the calendar year following the transfer. 

Under Section 211.27a of the General Property Tax Act (GPTA), a “transfer of ownership” that would uncap a property’s taxable value means “the conveyance of title to or a present interest in property, including the beneficial use of the property, the value of which is substantially equal to the value of the fee interest.”

Property owners often unknowingly stumble into an uncapping event, thinking certain types of conveyances don’t qualify as a “transfer of ownership,” especially those involving trusts or business entities. Indeed, there are designated exclusions for specific kinds of transactions. The application of these exceptions can, however, be nuanced and confusing. Consider these examples:

Conveyances Involving Trusts: 

• A conveyance to a trust is an uncapping event, except:
  • When the sole beneficiary of the trust is the transferor or the transferor’s spouse or 
  • When the beneficiary is the settlor/transferor’s (or settlor/transferor’s spouse’s) mother, father, brother, sister, son, daughter, adopted son/daughter, grandson/granddaughter, and the property is not used for a commercial purpose. 

• A distribution from a trust is an uncapping event, except:
  • When the distributee of the trust is the transferor or the transferor’s spouse or
  • When the real property distribution is made to the settlor/transferor’s (or settlor/transferor’s spouse’s) mother, father, brother, sister, son, daughter, adopted son/daughter, grandson/granddaughter, and the property is not used for a commercial purpose.

• A change in trust beneficiary is an uncapping event, except: 
  • When the change adds or substitutes the spouse of the sole present beneficiary; or
  • When the change is made, which adds the settlor/transferor (or settlor/transferor’s spouse’s) mother, father, brother, sister, son, daughter, adopted son/daughter, grandson/granddaughter, and the property is not used for a commercial purpose.

Conveyances Involving Business Entities

For uncapping purposes, a “transfer of ownership” includes: 

“a conveyance of an ownership interest in a corporation, partnership, sole proprietorship, limited liability company, limited liability partnership, or other legal entity if the ownership interest conveyed is more than 50% of the corporation, partnership, sole proprietorship, limited liability company, limited liability partnership, or other legal entity.”

Additionally, a simple transfer from Dan Campbell into Gritty, LLC is an uncapping event regardless of ownership interest in the company. So, too, is a transfer from one business to another and a transfer to a trust without meeting one of the previously discussed exceptions.

Conveyances That DO NOT Constitute a “Transfer of Ownership”

In addition to the exceptions described above, the following types of conveyances are not considered a “transfer of ownership” that would uncap a property’s taxable value:

• Transfers from one spouse to another or from a deceased spouse to a surviving spouse.
• Since December 31, 2014, a transfer of residential property if the transferee is the transferor’s or the transferor’s spouse’s mother, father, brother, sister, son, daughter, adopted son, adopted daughter, grandson, or granddaughter and the property is not used for a commercial purpose.
• A transfer of real property or other ownership interests among members of an “affiliated group,” meaning one or more corporations connected by stock ownership to a common parent corporation. 
• A transfer of real property or other ownership interests among corporations, partnerships, limited liability companies, limited liability partnerships, or other legal entities if the entities involved are commonly controlled. 

Given the complexities involved in structuring conveyances in a way that steers clear of an uncapping event and potentially avoids a significant tax burden, you should consult with experienced counsel before engaging in any transfer of real property in Michigan.

If you have questions or concerns about the uncapping of taxable value for Michigan real property, please contact Andrew Harris at Maddin Hauser.