Common Trusts for Homes in Northern Michigan
Trusts can help protect and preserve your family home or cottage now and for your future generations. But it’s vital to understand which type of trust will work best for you.
Many families own second homes and cottages in northern Michigan where they enjoy their vacations and build lasting memories together. And like many vacation property owners, they’ll likely want to preserve these homes and cottages for future generations.
A popular and increasingly common way to accomplish this goal is to take advantage of an estate planning tool called a trust.
Among other things, trusts are used to help families protect their property and ensure it remains in the family so that their heirs can continue to enjoy it. But there are several types of trusts, and one may be better for a particular situation.
Which Trust is Best for You?
Some trusts are more popular than others, especially when vacation property is involved. Here we detail the most common trusts for second home properties located in northern Michigan. These trusts include:
If you own a vacation property here up north, once you start thinking about your estate plan you’ll likely encounter at least one of these following trust types.
A revocable trust is a popular option for property owners for two primary reasons. And in some circumstances, it also may be a good option for parents who own a seasonal property or second home in northern Michigan.
First, upon their inheritance, your beneficiaries will be able to avoid the probate process. This is desirable because probate is often lengthy, expensive, and reduces privacy if the details of a probated estate become available as public record.
The second reason revocable trusts are popular is due to how the real estate held in them is valued after it’s transferred to the beneficiaries.
As an example, if you purchased your property 10 years ago for $200,000, that amount would be considered your original basis. If you sold it today for $500,000, you would have to pay capital gains taxes on the $300,000 difference.
But with a revocable trust, when your children take ownership, they’ll enjoy a “step up” in basis to the current fair market value. So if they together agree to sell it, their capital gains tax would be greatly reduced.
Another attractive aspect of a revocable trust is that it still allows you continued use and control of your property. And importantly, there will be no change, for you, in its taxable value, so your tax bill will remain the same as before.
Also, as the name implies, you can change a revocable trust or revoke it altogether.
So when properly constructed, a revocable trust let’s you and your family continue to enjoy your vacation property while you’re still alive. And when it’s time for it to be left to your children, they can avoid a lengthy and costly probate process.
But there are several potential downsides to using a revocable trust for vacation property.
- Joint Ownership by Beneficiaries: This single issue is perhaps the biggest disadvantage of a revocable trust. If you have two or more children named as beneficiaries of your trust’s property, they will take ownership of it as “joint tenants” with rights of survivorship. This means each of them will share equal ownership in the property for life, with each having an equal say about every single decision concerning the property. They will have to cooperate and agree on everything, including on who maintains it, who can use it, when it can be used, and even if one wants to sell and the other does not. Parents should take great caution when considering this point alone.
- Property Taxes: In Michigan, a property’s taxable value (provided there are no additions) will not increase by the lesser of the consumer price index (CPI) or 5% each year. But when a property has a “transfer of ownership,” a limitation on its taxable value is “uncapped.” This uncapping means that the taxable value for the new owner will increase to the state equalized value (SEV), and thereby increase the property taxes (which nobody wants). The good news is that Michigan does not consider property that is conveyed into or distributed out of a trust where the beneficiary is your or your spouse’s immediate family (your parents, siblings, children, etc.) as a transfer of ownership. However, if the beneficiary is not your immediate family (for example, a cousin or friend), then the taxable value will be “uncapped” which can lead to substantially increased property taxes. But whether your property’s taxable value will remain capped or not, it’s important to consider if the beneficiary will be able to afford the property taxes to begin with. In many cases, inheriting your property can become an unaffordable burden for your children, even to the point where it’s difficult for them to liquidate the property in a sale.
- Renting Considerations: Especially in Northern Michigan, it’s not uncommon for those who inherit a vacation property to consider turning it into a rental to create income. However, Michigan law considers inherited property used for commercial purposes (such as renting) to be a transfer of ownership – regardless whether the beneficiary is immediate family. As mentioned above, when there is a transfer of ownership the cap on the property’s taxable value is removed and results in increased property taxes.
- Creditor Claims: Unlike an irrevocable trust, property in a revocable trust is not shielded from creditor or judgment claims. So for those who are in careers with high liability risk, such as physicians, a revocable trust could be suboptimal.
- Long Term Care & Medicaid: A vacation property held in an revocable trust is still considered a “countable asset” by Medicaid. This means that the property’s value will cause you to exceed the allowable asset (or resource) limits to receive Medicaid payments. If you were to require costly nursing home or other long term care, you might have to pay out-of-pocket which could force you to sell the property.
As you can see, while revocable trusts may be popular with many property owners, it doesn’t necessarily mean they are the best choice if you own a second home in northern Michigan.
In 2014, there was a change to Michigan’s General Property Tax Act that redefined what counted as a “transfer of ownership” for real property (see MCL 211.27a).
Now often referred to as a “cottage trust,” its primary purpose is to allow families a way to transfer their vacation properties to future generations without increasing (or “uncapping”) the property’s taxable value. This feature alone makes it ideal for estate planning when the plan includes a seasonal home or property up north.
But there are many other benefits and advantages of a cottage trust, including the following:
- Retains the use of the property for the owner after transferring it to the trust. You can also transfer your property during your lifetime or upon your death.
- Allows transfers of real property between close family members without increasing its taxable value. This helps the family save on property tax expenses over time.
- Avoids probate when the original owners pass away.
- Shields the property from creditor claims, and the property will be an “uncountable asset” by Medicaid.
- Allows for succession planning to govern the future use of a home or cottage. In contrast to a revocable trust, rules can be set up to determine who can use the property and when, as well as restrictions of how it can be used. You can even assign responsibility for operational items like bill payment, maintenance and repairs. Also, guidelines can be created for resolving family disputes and making decisions about selling the property.
There are of course some important stipulations that must be satisfied before a property can qualify under this law. These include:
- The property must be classified as residential. Homes, condos and cottages in Harbor Springs, for example, fall within this classification, but it also includes recreational properties such as hunting and fishing camps, and even mushroom hunting land.
- There can be no commercial use of the property after the transfer, such as for a rental (limited to 15-days per year).
- The property must be part of a life estate (or life lease).
- The sole present beneficiary must be the settlor’s (the owner or the person who is transferring the property to the trust) father, mother, brother, sister, son, daughter, adopted son, adopted daughter, grandson, or granddaughter.
Importantly, a cottage trust is technically similar to an irrevocable trust that is specifically created for keeping a vacation property in the family. So when the intention and presumption is that your Up North vacation property will be kept and used by future generations, implementing a cottage trust might be the good choice for many families.
Domestic Asset Protection Trust
Thanks to a 2017 change in Michigan law, families with valuable assets, including real estate, can take advantage of a domestic asset protection trust (DAPT).
A type of irrevocable trust, DAPTs enable families to protect and preserve their assets now and for the benefit of their future generations. But this type of trust isn’t for everyone.
Creating and maintaining a DAPT can be very expensive. They are complex instruments and require the expertise of highly skilled and specialized attorneys and financial advisors.
Also, since a DAPT’s primary purpose is liability protection, it is generally best suited for people with considerable wealth and assets.
An important reason for this is that a DAPT greatly limits the ability of creditors to reach the assets. So if you work in a profession with high liability risk, such as a physician, or own a large and valuable business, a DAPT can be a great estate planning tool.
Some interesting features of a DAPT include:
- Irrevocable: DAPTs are irrevocable trusts so it’s important to understand that once an asset, such as a vacation home, is transferred to the trust, it’s very difficult to get it out or to sell it.
- Legal: A primary legal requirement for a DAPT is that it is governed by Michigan law. This could be an important consideration for families with property in northern Michigan who are from or reside out of state.
- Probate Avoidance: Assets in a DAPT are not subject to the probate process.
- Control: Called a “qualified disposition,” when your home is transferred to the trust it will then be governed by the trust. You give up control over it in favor of the DAPT, but you’ll retain some veto power over decisions. Importantly, you also still retain a “beneficial interest” in the trust, meaning you can continue to access, use and enjoy the property.
- Selling: You or other family members who are trust beneficiaries cannot sell, transfer or assign your interest in the trust. This prevents family members from transferring to others their beneficial interest (access, use and enjoyment) in a trust asset such as your home or cottage.
- Responsibility: DAPTs are overseen or managed by a trustee. As the legal owner of the trust’s assets, the trustee is responsible for things like filing its taxes, managing its assets, distributions, and generally making all the decisions according to the terms of the trust. Importantly, as the transferor or settlor of the DAPT, you cannot also serve as trustee, nor can you direct distributions from the trust.
- Marriage: A DAPT can be used as a sort of prenuptial agreement. For example, if a family vacation home is transferred to the trust more than 30 days prior to a marriage, the home will not be considered marital property upon an annulment or divorce.
Remember, a DAPT is a very specialized type of trust that is primarily suited for very wealthy families with valuable assets. Their primary concern for creating a DAPT would be protecting these assets from liabilities that may be inherent in their personal or professional lives. And when it comes to a home or other type of property they may own in northern Michigan, their goal would be to ensure their family can continue to enjoy the property, stress free, now and for generations to come.
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