Navigating the Michigan General Property Tax Qualified Agricultural Property Exemption

The Michigan General Property Tax grants two significant exemptions from the levy of taxes by school districts. They are the qualified agricultural property exemption, and the personal residence exemption (see, The Michigan Property Tax Personal Residence Exemption, in Michigan Estate Planning Blog). The agricultural exemption is obviously important to farm clients. However, the personal residence exemption is also important the two interrelate in some unexpected ways. It will be well for a farmland owner to familiarize her/himself with both exemptions and their quirks.
Exemption From School Tax
Both of these exemptions provide essentially the same relief from real property taxation; exemption from the school tax. Because the school tax is generally the largest of taxes levied in a particular locality, this is an important exemption. In the case of farmland owners, there is some real fairness to this in a land-value based tax system. A single farmer may own 100's or even 1000's of acres of land, all subject to Michigan's ad valorem land – based tax. A typical non-agricultural homeowner generally will own their home, but a fractional amount of acreage. Yet each has essentially the same statistical family, and therefore each sends the same statistical number of students through the local school system.
Classification
Land that is classified as "qualified agricultural land" in Michigan is automatically exempt from the school tax. With the personal residence exemption, the homeowner must qualify by demonstrating that they intend to live there permanently and must file an Affidavit of Personal Residence with the local assessor. The mere classification of land as residential has no bearing on the exemption (other than only residential classified land qualifies, of all other conditions are satisfied). An owner of qualified agricultural - classified land does not need to file anything. However, if the land is not classified by the local assessor as "qualified agricultural land," and the owner is conducting agricultural activities on it, there is authority under the statute for the owner to file an Affidavit. In the case where an Affidavit needs to be filed, it must be done by the same May 1, deadline as the personal residence exemption.
Ownership
Another difference between the two exemptions is that, unlike the personal residence exemption, the land may be owned by a corporation, partnership, LLC, Trust or similar entity and still qualify for the exemption. A transfer of farmland to one of these entities for estate or succession planning will not rescind or otherwise harm the exemption. However, the law indicates that if there is a personal residence on the agricultural property, the owner-occupant may not claim a personal residence exemption on another property.
The local assessor may allocate properties that are in "mixed – use," applying a percentage of exemption to the parcel. This can be tricky. The ad valorem tax nature of the tax means that the allocation must be made based on the value of the particular percentage of the property being used, rather than a straight geographical determination. In other words, a 40-acre parcel may have a commercial facility occupying 1 acre. It is not correct to assume that the parcel remains 98% (39/40) exempt. Rather, a fraction of the value of the commercial facility divided by the overall value of the 40 acre parcel would be the correct way to determine the amount remaining qualified and therefore exempt. This is a lot more subjective and perhaps lends itself to a certain amount of uncertainty and lack of clarity.
It is also problematic, in my view, that the guidelines published by the Michigan Department of Treasury ("State Tax Commission Qualified Agricultural Property Exemption Guidelines"), define "agricultural use," but they do not define other uses such as "commercial / industrial" use, even though they make reference to it. One question this leaves open to interpretation is what the effect is of incidental non-farm related use and how much and how often an agricultural facility must be used for activity (e.g., temporary storage of agricultural commodities for a commercial operator).
Practical Concerns
I
have often said here (and elsewhere) that farmers and farming are unique businesses and landowners. There are a lot of things going on with most farmland parcels. In addition to the "qualified agricultural property" tax classification, farmland is also often subject to Farmland Development Agreement Liens (so-called P.A. 116 Agreements), FSA agreements, wetlands agreements, and conservation easements. Transfer and conveyance of farmland often triggers issues regarding the Michigan Land Division Act, and "uncapping" issues.
More often than not these days, I find myself beginning my conversation with farmers in the "apology mode," explaining that unfortunately, what seemingly used to be relatively simple matters of the proverbial "quit claim deed," have now become very complex real estate transactions. I am not saying that all these rules, liens, taxes and exemptions make transactions unfeasible or impossible. But I am saying that it is important that all the proverbial "I's" and "T's" are dotted and crossed.
A
typical farm real estate transaction today involves analysis of many issues. In addition to correct legal descriptions and title evidence, we need to determine tax code parcel identification codes to see that they are accurate; P.A. 116 Agreement numbers (if applicable) and expiration dates, and whether a transfer is required; whether the proposed parcel transfer will itself qualify for P.A. 116; whether the transfer of a parcel involves a "division" or is exempt, whether a parcel contains a personal residence on which a personal residence exemption is being claimed; just to name a few of the issues. When transfers occur, we need to file a Property Transfer Affidavit and where applicable, an Affidavit of Agricultural Use to exempt the transaction from and "uncapping" transfer.
Unfortunately, gone are the days when a simple deed from one party to the other would suffice. Competent, experienced professional assistance needs to be sought when there are farm real estate transactions.

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Should You Convert Your Land Partnership to an LLC?

Since 1997, the Michigan Limited Liability Company Act has provided for an "automatic conversion" of Michigan Partnerships (both regular and Limited Partnerships) into a Limited Liability Company. Over the years, a lot of land-owners formed partnerships for various reasons, including succession planning, rent and tax considerations, and joint-ownership buy and sell provisions. In many (if not most) cases, there is little reason not to consider the conversion from a Partnership to a Limited Liability Company (LLC). There is a one-time filing fee for filing the Articles of Organization for the LLC, and an nominal annual fee and relative simple Michigan Annual Report. These are the only real changes to reporting and bookkeeping requirements. The organization will continue (in most cases) to file the Federal Income Tax Form 1065 (and MI 1065) with no substantial changes.

In return, the partners (now called "members") gain something pretty valuable—limited liability. Note that this limited liability only applies to incidents and occurrences after the conversion. You cannot use the conversion to "cure" a problem that arose prior to the conversion. In a traditional co-partnership, a partner is personally liable for all of the activities and liabilities of the partnership, even if it is one of the other partners who created the problem. Worse, a creditor can pick and choose which partner they want to pursue and can hold that one partner liable for 100% of the liability. The law takes the position that it is between the partners to allocate losses due to liability among themselves and not the problem of the creditor. Moving forward, the LLC form of business offers many opportunities to arrange the affairs and agreements among the members in some very flexible ways.

One concern about making the change is the so-called "domino-effect" it might have with all of the different facets of land-ownership. In most cases, there are mortgages, lease agreements, and often P.A. 116 Farmland Development Rights Agreements. The tax status of the property is also a potential problem.

Section 707 (5) of the Michigan Limited Liability Company Act provides that when an automatic conversion is done, the resulting limited liability company is "considered the same entity that existed before the conversion." The provision goes on to say that all the property rights of the prior partnership remain vested in the limited liability company. This means that on the record, nothing really changes. There is no requirement in the Act, other than the filing of the Certificate of Conversion (built into the Articles of Organization, if the proper form is filed), for filings, notices, or recording of new deeds. This should mean, as a legal matter, that no change in ownership, or transfer has occurred.

While it should be noted that specific situations are not directly addressed by the statute, the following concerns should be covered:

• Mortgage "Due on Sale Clauses" should not be triggered
  
• There should not be an "uncapping" for purposes of Michigan ad valorem real property taxes (while the Michigan Tax Tribunal has indicated that a transfer to or from a limited liability company is a "transfer" – and therefore an "uncapping" event – as a practical matter, the filing of an "Affidavit of Agricultural Use" generally cures that problem and unless there is a good reason not to, should probably be filed simply to take a conservative approach).
  
• A recent conversation with the Michigan Department of Agriculture informally confirmed that neither they nor the Michigan Department of Treasury require a transfer of existing P.A. 116 agreements upon an automatic conversion.
  
• Leases are rights in property and in accordance with the Act language, neither Lessor nor Lessee's rights and obligations should change or be effected by the conversion.
  
• Nor should Land Contracts, Purchase Agreements, Joint-ownership agreements, easements, licenses or any other property rights be effected by the conversion.
  
• The rights and liabilities of the Partners to each other should be essentially unchanged, and any Partnership Agreement should continue to be effective unless and until an new "Operating Agreement" is executed. Since banks and other third parties commonly request or require copies of the Operating Agreement, it may be advisable to either create a new agreement, or create one which "adopts" the existing partnership agreement.
  

  
  

As always, when dealing with legal matters, it is very dangerous to take a "one-size-fits-all" approach. Before making a conversion, it is critical that you consult with both tax and legal advisors to be certain there are no unintended negative consequences. For example, in some limited cases, if the Partnership/LLC is also the operating entity, certain third parties (notably the Farm Services Administration) may treat a LLC differently than a Partnership. That could have significant economic consequences. LLC's, by their statutory nature, can be very difficult to exit as an individual member, unless there are clear terms in the operating agreement. It is important to discuss all of these issues prior to making the conversion. As a practical matter, many of the Partnerships I work with have been in existence for many years, and it is often a good time to "dust off" the Partnership Agreement and revisit its terms anyway.

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Effective Estate, Succession and Business Planning for Farmers

Family Farm businesses are unique. Family farming may be the only industry where the owners live and work in the same place. Farm children grow up going to work with their parents every day. Many farm children ultimately become next-generation owners of the business.

But while they are family owned and oriented, most farming operations are also sophisticated and complex, capital intensive, multi-million dollar businesses. Farmers must be scientists, financial managers, personnel specialists, mechanics, and gamblers. They must also be well versed in land management, and government programs, including "Oil and Gas" lease issues and Wind and Alternative Energy leases and programs.

Family farm businesses are unique

Over nearly 30 years of representing family farm businesses, I have observed that an essential part of their success requires careful Estate, Business and Succession Planning. Because farm businesses are a mix of family and farming there are unique Estate Planning concerns that must be addressed. At the same time, because of the complexity of farm businesses, advisors must have a sound knowledge of the industry. Land use rules such as the Michigan Farmland Preservation Program (P.A. 116), the Michigan Land Division Act, the real estate and transfer tax rules for Agricultural property and homesteads, and Federal Land Programs need to be considered. When setting up a business entity such as a Corporation or Limited Liability Company (LLC), it is important to know not only what the tax consequences of such an entity will be to the farmer, but how federal and state government programs will treat them. It is also important to know how the Secretary of State will view the transfer of trucks and equipment within such entities. Finally, consideration must be given to ensuring that adequate and thorough insurance coverage will be maintained.

Every significant participant in the family farm should have a personal Estate Plan, including appropriate documents designating appropriate distribution of assets and management of their affairs in the event of incapacity. A good, comprehensive Estate Plan should include, where appropriate:

• Trusts,

• Wills,

• Durable Powers of Attorney and

• Health Care Designation of Patient Advocate

Every significant participant in the farming operation should have their own estate plan

Importantly, the advisor needs to truly understand how these tools should be integrated to coordinate with the overall business and plan.

In today's farm industry, it is not uncommon for a farm to have several entities which may own "operations," land-holding entities, equipment, and other valuable assets. Part of the plan may be to segregate or compartmentalize different assets or asset groups. This can help with the incremental transfer of assets to the next generation and can also result in more effective asset protection for the owners. Entities and related tools which should be considered are:

• Limited Liability Companies (LLC's)

• Corporations (often "sub-chapter S" corporations)

• Land Ownership Agreements

• Lease Agreements for Farm Land, Oil and Gas, Wind, and Solar energy

• Equipment Lease Agreements

Occasionally, more sophisticated arrangement, like Family Limited Partnerships and special trust arrangements may be called for, but most often they can be handled adequately with the above listed tools.

When planning to transfer assets to the next generation, there are numerous concerns that both generations have. These concerns can create tension between the participants before and during the planning process. However, experience teaches us that we are better off to address the concerns head on and have a plan in place than to simply bury our heads and "hope." The current owners are often concerned that the next generation is not ready to shoulder the significant responsibility, that their decision-making is often driven by less practical and more theoretical objectives. They are fearful of over-extension of debt and of decisions that are not informed by experience. The older generation often perceives itself to be more frugal than the younger generation.

The younger generation can at times feel unappreciated and feel that the older generation's hesitance is holding the operations back. And, often, they are not given any concrete assurance that they will eventually play a significant part and become an owner of the farming business.

Reality is often somewhere in between. Good succession planning will allow the older generation to transfer significant wealth to the younger generation, but retain substantial control over the operations. It can also assure desired income for retirement to the transferring generation. With proper planning, we can transfer wealth, reduce or eliminate taxation, and give the younger generation an incremental part in the business and—eventually—succession to ownership.

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