Tax audits for homesteads

December 1, 2016

 Owning a home provides many benefits, from the pride in having a place of your own, to being able to take a deduction on your annual tax return. One responsibility of home ownership is paying property taxes to your municipality, which includes funds to the state which come back to local school districts as per-pupil funding. When the home is your primary residence, homeowners pay the municipality's annual millage rate. However, if the home is a second, or other non-primary residence, the non-principal residence tax can run up to 18 mills, depending on the approved millage for the district. 

When the home is the principal residence, homeowners – those who own and occupy their home – can file a principal residence exemption (PRE). In state audits, approximately 99 percent of PRE filings are found to be valid. However, there are thousands of tax exemptions that are denied at the municipal or county level, as well as during the audit led by the Michigan Department of Treasury. Which means that there are hundreds of thousands of dollars the state, local municipalities and school districts are missing out on.

The PRE became available in 1994, as a result of the passage of Proposal A, a statewide effort designed to cut and cap local property tax burdens, and to gradually reduce the disparities in school funding, and provide tax relief to property owners.

“It essentially changed, to a great effect, the percent of education revenues coming from property taxes, and shifted it over to sales tax,” said Andy Meisner, Oakland County Treasurer. 

Governed by the regulations established in the General Property Tax Act, to claim a PRE the homeowner/occupier must file a form with the local municipality, at which point the exemption information is posted to the local property tax roll. Second homes, vacation homes and income property may not be claimed because they do not serve as an individual’s principal residence. 

Additional exclusions to the exemption, and/or grounds for denial, include claiming a similar exemption, deduction or credit on a property in another state that has not been rescinded; claiming the PRE for another property for the same tax year; and filing income taxes as a resident in a state other than Michigan. Exclusion also applies in cases where the homeowner or their spouse owns property in another state – for which an exemption was claimed – unless, that person and their spouse file a separate income tax return.

Under the changed tax structure, which has been the norm for over 20 years, the school operating millage applies only to non-principal residence properties, such as a cottage up north, or a second home that an individual owns and leases as a rental property. While property taxes account for a smaller percentage of the local school operating budgets as a result of Proposal A, the school operating millage continues to be the most significant source of operating funds.

While the exemption provides an incentive to homeownership, there are a host of hiccups associated with the tax break that can lead to savings for thousands of property owners across the state. Yet many believe the School Aid Fund gets robbed of dollars that could provide for better programming, more up-to-date materials or higher paid teachers.

Some property owners who are found to have an illegitimate PRE on file specifically attempted to outwit the system to save money, but other cases that lead to a denied PRE arise less intentionally. Eligibility for the exemption hinges on both ownership and occupancy, so problems can arise with the validity of a homeowner’s PRE when a realty agent provides the PRE affidavit at the time of closing on a sale if the individual has not actually moved into the home yet. 

Another common error that may occur mistakenly is when someone moves into a nursing home full-time, but never formally rescinds their PRE, as the law requires. Such a scenario could result in grandma or grandpa, or their family members, receiving a hefty bill for back taxes – plus interest – when they were not deliberately dodging in the first place. 

Audits to find those who should have been paying on extra properties have been conducted by the state of Michigan since September 2006, when the state entered into a contract with Tax Management Associates to conduct an annual audit. Tax Management Associates reviews PREs for parcels in 40 or more of the 83 counties statewide.

The 2015 state-led audit led to the denial of nearly 10,300 PREs that were previously on file, and uncovered an estimated $18.3 million in back taxes owed to the School Aid Fund, according to Danelle Gittus, Michigan Treasury Department Public Information Officer. The actual disbursement of money into the School Aid Fund depends upon successfully recovering the money due. In 2014, Gittus said, the state found roughly 6,300 denials that would have amounted to $14.1 million in recovered money. And, in 2013, the state issued over 5,900 denials – amounting to $14.8 million in additional funds owed to the state’s School Aid Fund.

“The PRE is tied to state tax. When someone is not paying that, but they’re not eligible to have that exemption, then it would be the schools that would suffer the brunt of the harm of that,” said Oakland County treasurer Meisner. “At a time when school funding from Lansing has been very volatile, that could really make worse some of the financial challenges that our school districts are going through.

“For folks that are eligible, they are not required to pay the (up to) 18 mill tax, the state education tax, so it’s a significant tax benefit given to people who claim it because it’s knocking out a big amount of property taxes,” said Meisner. 

Voters within the districts of Rochester Community Schools and Avondale Public Schools approved the maximum operating millage, meaning that homeowners who don’t file a PRE with the municipality are charged 18 mills annually, or $18 on every $1,000 of taxable value. Homeowners within the boundaries of Bloomfield Hills Schools who don’t claim the PRE – in other words, whose primary residence is not in the district – pay 10.2740 mills to the district annually. And Birmingham residents without a PRE on file are billed each year for 9.2728 mills to fund the Birmingham Public Schools operating expenses.

“There are seven general reasons for a PRE denial,” said Gittus with the state treasury department. “They include unqualified land, rental property, partial exemption, non-owner occupied, non-resident owned property, property owned by a company, and failure to respond to a request for information.” 

According to the Principal Residence Exemption Audit Report, published in December of 2015 by the treasury department, the three most common reasons for denial are due to the failure to respond to request of information; claiming an exemption on property that is not occupied by the owner; and claiming the exemption on a property that is a rented rather than owned.

The most common reason for denial in Oakland County in 2015 resulted from failure to respond to an inquiry initiated by the state, which accounted for 514 denials, or 58.6 percent. Exemptions that were claimed for a home that the owner does not live in accounted for 194 denials, or 22 percent. And PREs claimed for a property that was rented accounted for 16 percent of the denials. 

In 2015, the state treasury department audited 58 counties, generating exemption denials for nearly 10,300 parcels, of which 40 percent were in located in Wayne County. Six additional counties – namely, Oakland, Macomb, Genesee, Kent, Bay, and Ingham counties – accounted for another 29 percent of the total. That year, Wayne County had 4,302 denials, compared to Oakland County’s 877 denials. 

However, in 2012, the first year that Oakland County was audited by the state under the contract with the private auditing firm, the two counties had roughly the same number of denials. Wayne County tallied 1,780 denials, only 27 more than Oakland County’s 1,753. 

“Beginning in 2009, the election to audit is made every five years,” stated Ron Leix, public information officer at the Michigan Treasury Department. “Currently, treasury is required to audit 40 counties that have not selected to do their own. However, treasury may still audit PRE claims in those counties that opt to do their own audits. Treasury makes the determination to audit opt-in counties on a yearly basis, based on criteria that is considered confidential.”

The steep drop in denials issued by the state for Oakland County from 2012 to 2013 illustrates the impact of the first round of robust sweeps of the county’s PREs. The professional audit wiped off roughly 1,000 exemptions that had previously been on the books. Since 2012, Oakland County has opted to have the state conduct the audit, a choice which ultimately benefits the state’s school districts because the state, with access to a much larger database of information, has the ability to catch illegitimate PREs that can slip through the cracks at the local or county level.

“(The state) has more information on people through income tax filings and they have reciprocity agreements with Florida (and other states). They can check in Florida to see if someone has a homestead filing in Florida,” said Kurt Dawson, Rochester Hills Assessor/Treasurer, referring to the PRE, which was known as the homestead exemption until 2004 when the term ‘homestead’ was replaced with ‘principal residence.’ 

“They have the ability to audit beyond the information we have,” Dawson said. “Ours are a pretty basic audit routine – a name mismatch, or if they are not registered to vote here. The state has income tax records and can do a deeper audit. The state requests the jurisdictions' tax rolls and they query who has a homestead and who doesn’t, and from that they can determine, ‘should it be looked at?’. They run it by Social Security number.”

Still, Dawson said, “We’re always looking at records, running reports. We do good guy/bad guy audits. We’re the good guys when we put people on the (PRE) list, who might not have known they qualify, and the bad guys when we take them off (due to ineligibility).”

At the local and county level, there are a number of situations that can alert the assessor to a potentially illegitimate PRE. Many of these triggers involve PRE forms with mismatched addresses. Examples include having a driver's license that lists a different address; being registered to vote at a different address; having a utility bill registered at a different address; among others.

When the assessor takes note of something suspicious on the forms and the question of eligibility lingers, additional information is requested from the homeowner. The assessor’s office may call, email or send a letter requesting clarification.

In 2013, the Rochester Hills assessing office sent out 160 letters and denied 51 PREs. In 2014, there were 21 letters mailed, and 92 PREs denied. In 2015, there were 23 denials, none of which required further investigation. 

Once a denial is issued and the PRE is removed, it can retroactively effect the taxpayers status for the previous three years. When the denial is for a PRE filed in the current tax year, the local municipality issues the bill for the remaining balance, but when the individual owes taxes from years prior, the county issues the bill. The homeowner will be requested to pay the full difference between the PRE and non-PRE rate, in addition to a 1.25 percent interest rate.

In response to PRE denials discovered in 2013, the county billed and collected $46,418 from Rochester Hills homeowners, and issued the money to Rochester Community Schools and Avondale School District. In 2014, the county billed Rochester Hills homeowners for $35,083, of which $3,066 has yet to be collected. In 2015, the county issued revised property tax bills to Rochester Hills residents totaling $39,443, of which $2,484 remains due. 

A similar scenario exists in Bloomfield Township, for which the county treasurer issued revised bills totaling $200,527 between the years 2013 and 2015. At press time, $4,213 is still outstanding. The money is owed by a handful of township residents, and belongs in the budgets for Bloomfield Hills Schools and Birmingham Public Schools. 

Darrin Kraatz, assessor for Bloomfield Township, said, “As far as an official audit, like the state is doing, we don’t have any way to ­audit the entire database, but when a red flag is raised, we investigate it. 

“A lot of people don’t know any better. A lot of seniors bought a home in the township prior to 1994, and forgot they filed (the PRE). They don’t even know they have it, and they move to Florida, and apply down in Florida for the homestead (exemption), so we get in touch with them.

“There are a lot of people getting the homestead who shouldn’t, and (the state) has the ability to check these people. They may have it and not even know it. (The assessor in) Charlevoix has no reason to check Bloomfield, and we have no reason to check Charlevoix, because the homestead’s been on his property since 1994,” Kraatz said. “But the state can say, ‘Oh, this is the same John Smith,’ so they try to get in touch with the person. If they don’t respond, the state denies one of the (PREs), and the county will send a bill and the local (tax unit) will send a bill for the current year.”

As a local assessor, Kraatz said Bloomfield Township “send(s) the state our assessing database and they perform the audits. We’ll get a denial list from the state of Michigan, saying they don’t qualify, then we remove the homestead (exemption). Then they get billed for the difference between the PRE and a non-PRE.” The treasury department issues the list of erroneously claimed exemptions to local governments to bill, as necessary, on an annual basis.

Between 2013 and 2014, the county treasurer’s office sent out bills totaling $28,440 after the state issued 291 denials for properties in the city of Southfield. Earmarked for the Birmingham, Southfield and Oak Park school districts, the county has received the majority, but is awaiting payment of $9,535. 

At the state level, the treasury department said it is unclear how much has been successfully recovered for the School Aid Fund as a result of the audits. 

“All we have is the estimated amount of savings to the School Aid Fund. There are many variables that affect the actual amount – as detailed in the (Principal Residence Exemption Audit) report – that it is nearly impossible to obtain an exact amount of back taxes paid to the state,” wrote Leix, public information officer for the treasury, in a statement.

The money generated from the 1.25 interest rate that’s charged to unpaid back taxes is dispersed three ways – to the treasury department, the local assessing office, and the county where the property is located. The amount each receives depends on which unit of government issued the denial.

“When the department of treasury issues a denial, 70 percent of the collected interest is deposited into a restricted fund at treasury which can only be used for PRE audit purposes,” said Gittus with the state. As for the remaining 30 percent, the local tax collecting unit receives 20 percent of it, and the county where the property sits receives the leftover 10 percent. 

If the assessor of the local tax collecting unit catches and denies the exemption, the office will receive 70 percent of the interest, while the county in which the property is located will receive 20 percent, and the remaining 10 percent is sent to the treasury department. A similar breakdown occurs when the county equalization office identifies and denies the PRE, with 70 percent going to county.

Joyce Bowers, supervisor of the Oakland County Equalization Office, said, “We have reports that we run in our database every year, like if there’s a different mailing address, we’ll look at why. We run audits on a yearly basis.” However, the investigation on the part of the county assessor’s office primarily focused on the 32 communities that the county contracts with to provide assessing services, including the cities of Birmingham, Bloomfield Hills and Rochester.

In 2015, the county equalization office denied 16 PREs for Birmingham, generating a total of $24,315 in property taxes that were due to the school district. The year prior, illegitimate PREs in Birmingham accounted for $49,536 from 39 denials.

Bloomfield Hills in 2015 saw seven denials, which totaled $29,997 in back taxes owed to the local district, and in 2014, the city had nine denials, totally $22,698.

Rochester schools were shorted $2,855 from six illegitimate PREs found by the county equalization office in 2015. The year prior, there were 22 Rochester properties’ denied, which amounted to $21,939 billed by the county on behalf of the local school districts. 

“When it’s found out that it’s filed (illegitimately), we will do a denial. They get mailed paperwork, and they have a right to appeal to the Michigan Tax Tribunal. They will get a tax bill for the portion that they did not pay,” said Bowers.

Appeals to denials that were issued by the local assessor or the county are filed with the residential/small claims division of the Michigan Tax Tribunal, and must be made within 35 days of the denial. Appeals of denials issued by the treasury department are initiated by filing a petition with the hearings division of the state treasury.

The success rate of appeals ranges from approximately 15 percent to 23 percent. Leix, with the treasury, said 23 percent of the appeals are overturned in full, whereas 15 percent of the appeals are partially overturned – an outcome that occurs upon receiving a partial exemption from the local school operating millage. 

A partial exemption, characterized as a percentage, may be issued when a homeowner turns a portion of the house into an office or business-related space, or if the homeowner occupies the home while also renting a portion of the house. In these cases, the homeowner can claim a partial exemption depending on the amount of square footage dedicated to the home versus the business enterprise or tenant. A partial PRE may also be claimed by someone who owns and occupies a portion of a duplex or apartment building.

Another exception to the rule exists for active-duty military personnel. Those with an established PRE can retain that PRE while active in the armed forces, even if the person chooses to rent or lease their home. Additionally, a person is allowed to maintain an established PRE for up to three years on a home that was formerly their principal residence, but has since been put up for sale when they move into a new home. 

So, while under certain circumstances, having two PREs may be permitted, Oakland County Assessor David Hieber said, “Someone can be creative, and have two PREs for a while… and have moved to another state. Then the only recourse is to sue them, and now they live in Montana, so those are probably considered uncollectible. So there is some loss due to illegitimate PRE claims, or (from) mistakes that people make and do not even know.”​
 

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