Huey Real Estate, LLC
PO Box 146
Marquette, MI 49855
"What are the Taxes?" -- Why that is not always easy to answer.
The taxes currently being paid on the property will change when it is sold, so whatever the property owner is paying now, especially if he has owned it for a long time, is not relevant to what you will pay. The tax system is a complex process that can produce varying results, and will be influenced by choices that you make, some of which are summarized below.
"Millage" is the tax rate levied against property, expressed in tenths of a cent. For example, "38.41 mills" = $0.03841 per year, which is multiplied times the new State Equalized Value (SEV) of your property to determine the tax owed. In this example that would be $32.41 per thousand dollars of SEV.
Commercial Forest Act
The Commercial Forest Act is relatively unknown and unused below the Mackinaw Bridge, but it has had a significant effect on life in the U.P. Half the land in the U.P. is in public ownership. The majority of the rest is owned in large tracts by timber and mining companies. The Act bypasses the local assessment and millage tax system described here and instead currently (2011) offers reduced tax rates of $1.20/acre for owners of 40 acres or more when property is properly registered and used solely as commercial forestland. (These rates are scheduled to increase by $0.05/year starting in 2012.) In return, public access to this land is required for the walking public for purposes of hunting and fishing. (Landowners retain all other private property rights.) It is this act that has made so much of the U.P. accessible to the public and it can significantly reduce the taxes on your property.
CFR land can be transferred and can also be withdrawn from the Act at any time on payment of a penalty that amounts to the difference between the ad valorem tax rate and the rate actually paid under CFR (usually about a third of the typical ad valorem rate). Usually I have found that the penalty for property that has been held for seven years or more runs $25 - $30/acre. Copies of the Act are available from the Michigan DNR, and you can read all about it on the official state website at Commercial Forest Act. You will see "CFR" in the plat book on tracts that have been so designated.
"Homestead" designation has a big effect on taxes. Your designated home in Michigan qualifies as "Homestead" property which is taxed at 18 mills or $18 per $1,000 of taxable value less than other real estate such as vacant land, a vacation home, or commercial property. You can only have one Homestead property, but interestingly an attorney friend tells me the law considers "home" to be where the heart is, not necessarily where you spend most of you time.
Taxable Value, Assessed Value, True Cash Value, & State Equalized Value (SEV).
Brokers are advised and assessors recommend that you use the price you expect to pay for the property when you estimate its likely "true cash" value. That should be the "worst case" for estimating your future taxes, so that has to be what I advise and I do. However ...
When property is transferred the local assessor is required to re-assess the property based on all the comparable sales in his taxing jurisdiction over the last three years and ignoring what you paid for it. Note that this is a back-loaded process that by definition does not reflect the current value unless the three-year-old sale prices are adjusted for time. Under Michigan law the value he places on the property is the "true cash" value. In theory (but rarely, in my experience, in practice,) is the price the property will sell for in the marketplace.
As a practical matter you may also wish to look at the valuation of comparable properties in the area of your interest. I frequently see "true cash" that are less that market value, in some cases much less. We all complain about our taxes and think we are over-assessed, and you can relate to this wherever you are with respect to your own taxes, but in fact I rarely find a seller who is willing to sell his property for itâ€™s "true cash" value. When that happens if you use the anticipated purchase price in estimating your "true cash" value and your future taxes, you may not be dealing with a real world number and may elect to not buy the property for the wrong reason. Typically rural properties will seem to be assessed lower than more developed areas. Look into this on your own and make your own decision.
I have attached below a PDF of a 2006 memo from the State Tax Commission to Boards of Review Assessing Officers. It clearly states, "... the SEV of the property will not automatically or necessarily equal 1/2 of the sale price of the parcel." And, "THE PRACTICE OF 'FOLLOWING SALES' IS A SERIOUS VIOLATION OF LAW."
Click here to see the PDF for the complete memo on how it is supposed to work.
At minimum your assessment will not be less than the current SEV unless you are successful in an appeal, and the SEV/first year Taxable value, will probably be increased by the Assessor. Real estate tax obligations can change significantly when property is transferred. Under Michigan law property is taxed at 50% of the "true cash" value. The county reviews the total value of the property in each category and may require the local assessor to make an adjustment to the total valuation in his jurisdiction. The final result is the "state equalized value" or "SEV".
In the first year of ownership your SEV will also be the propertyâ€™s "Taxable Value", the amount on which you are taxed. After the first year in Michigan under Proposition "A", increases in TV are limited to the lesser of the rate of inflation or 5% (plus any improvements to the property). Over time this will encourage owners to hold and improve property, as a parcel that has been owned for a long time will pay less tax than an identical adjacent parcel that has transferred more recently. California has a similar system and that has been a result there.
Summary: True Cash/2 = Assessed Value/SEV = the 1st year Taxable Value. Subsequent years SEV may rise but TV is capped at the lesser of 5% or the rate of inflation multiplied by the voted millage = your tax. If the property is Homestead property the millage will be 18 mills less than any other property you own.
I do not set your future taxes, have no precise way of estimating actual taxes, they will be set by assessors who may have their own notions as to how this should be done and I have no control over it, so if you want further information call the local assessor or the Equalization Office in the governmental jurisdiction where the property is located and talk to them directly. I have found the people who work in these offices to be most helpful and informative.
A taxpayer in the 15 percent marginal tax bracket who sells property held less than five years pays a 10% capital gains tax; for property held more than five years the rate is 8%. A taxpayer in a 28 percent or higher marginal tax bracket pays 20 percent capital gains through 12/31/05. On or after 01/01/06 the rate drops to 18 percent if the asset s owned for more than five years.
Tax evasion is illegal. Tax avoidance is not. Disposing of one parcel of real estate and acquiring another with a properly structured 1031 exchange defers capital gains taxes until the replacement property is sold. However it can be exchanged again, deferring capital gains taxes further into the future. In this way the tax can be deferred indefinitely. A tax deferred is in effect an interest free loan from the government. Can you make money with an interest free loan? You bet. It is however critical that the letter of the law, not just the intent of the parties, is followed precisely to have a successful exchange, and there are some traps for the unwary. See your tax consultant and/or attorney.
No less an authority than a former Chief Justice of the Supreme Court has said, "The 1031 tax deferred exchange is the finest tax loophole available to the average American." He added: "It is the duty of every American to his family to pay the minimum tax that he is legally required to pay under the law."
"Section 1031" property is "property used in a trade or business or held for investment." Essentially that covers any real estate but your house. (Second homes may or may not qualify, depending on the circumstances.) "Held for investment" is a matter of intent. A typical exchange involves three or more people, not two. They are a person, "A," who wants to dispose of a property and defer capital gains taxes, "B" who owns a parcel "A" would like to acquire, and "C" who is willing to buy the parcel "A" no longer wants.
The first step for "A" is to find a buyer for the property he has. When "A" gets an acceptable offer, he accepts it with language that says, "subject to structuring a 1031 exchange." "A" now has a contract and knows how much he has to acquire a new property. The basic rule is that to achieve a totally tax deferred exchange one has to acquire a new property of equal or higher value. "A" negotiates the purchase of a new property he wants just as if he were "buying" it for cash, but he makes his offer to buy "subject to completing a 1031 exchange." This does not affect the "B" or "C", and their attorneys or tax advisors will tell them so.
In essence what happens at closing is "C" buys "B's" property for cash (taxable for "B"), and swaps that property for the parcel he wants from "A". "A" then has the property he wants and capital gains tax is deferred.
1031 exchanging is a big subject and cannot be boiled down to a few paragraphs. There are many additional advantages to exchanging. It is possible to get cash out tax-free by financing before or after the exchange. A free and clear smaller property can be exchanged into a much larger leveraged property. You can move from one type of property, vacant, income, management free or management intensive, to another.
A vacant parcel held for investment that has negative cash flow can be exchanged for a net leased income property with positive cash flow. An income property that demands constant management can be exchanged for a free and clear vacant parcel. If you are interested in 1031 exchanging call Huey Real Estate for a more complete explanation than is possible here. Again, all of this must be done precisely within the rules, they are complex, it adds a level of complexity, and usually takes more time, but if there is big capital gains the savings are significant, and the law is clear.