Buyers and sellers of real property typically expect some tax consequences from the transaction. However, they generally focus on federal tax issues, in particular issues that may impact their federal income taxes. But most states also impose various taxes that may affect the total cost of the transaction, and these are often not considered. One type of tax that should be considered is a real property transfer tax. It may come as a surprise that these taxes can result in a significant amount of liability, especially if the transaction involves a large amount of real estate.
What Is a Real Property Transfer Tax?
A real property transfer tax is a tax that is assessed by states, counties and/or municipalities on either the consideration received or the fair market value of real property for the privilege of transferring it within a jurisdiction. The tax rate varies widely by taxing jurisdiction. For example, the tax rate in Colorado is approximately 0.01 percent, while the tax rate for property in the city of Philadelphia is approximately 4 percent (3 percent city of Philadelphia plus 1 percent state rate). Although the individual rates may not seem significant, approximately 40 states plus local jurisdictions impose some type of real property transfer tax.
Real property transfer taxes are referred to differently by different jurisdictions; however, the way the tax is applied is very similar. These taxes are referred to as a transfer tax, recording tax, deed recording tax, mortgage recording tax, mortgage tax or documentary stamp tax. Regardless of the name, the real property transfer tax is typically assessed against either (1) the property interest that is transferred from the seller to the buyer; or (2) the document that is used to make the transfer, such as a deed or mortgage.
The tax is typically calculated based on the consideration paid and may or may not include encumbrances and/or liens related to the property. However, if the property is conveyed for a nominal amount, many states will impose the tax on the fair market value of the property.
Another factor to consider is the legal requirement to pay the real property transfer tax. Generally, it is the seller who is legally required to pay the real property transfer tax, but certain jurisdictions — such as Washington, D.C. — require that the taxes be split evenly between the seller and buyer. Regardless of the legal requirement and the party responsible for the filing and payment of the tax, the seller and buyer should consider who will ultimately incur the liability and ensure that this understanding is explicit in the purchase/sale agreement.
States also provide various exemptions for certain types of buyers and certain types of transactions. For instance, Washington state provides that a sale of real property does not include a transfer that for federal income tax purposes does not involve the recognition of gain or loss for entity formation, liquidation or dissolution, and reorganization, including but not limited to non-recognition of gain or loss because of application of 26 USC section 332, 337, 351, 368(a)(1), 721 or 731 of the Internal Revenue Code of 1986, as amended. If the transaction involves a bankruptcy, Section 1146(a) of the Bankruptcy Code provides that “the issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under Section 1129 of this title, may not be taxed under any law imposing a stamp or similar tax.” As demonstrated in the U.S. Supreme Court case (on certiorari from the 11th U.S. Circuit Court of Appeals) Florida Department of Revenue v. Piccadilly Cafeterias, the exemption only applies to post-confirmation property transfers under Section 363 of the Bankruptcy Code. Therefore, if the property is sold prior to a confirmed plan of reorganization, this exemption does not apply.
How Is the Real Property Transfer Tax Assessed?
Not surprisingly, the process for remitting the real property transfer tax differs by jurisdiction. Generally, the real estate transfer tax is required to be paid to the register of deed of the county in which the real estate is located before recording the instrument (deed or mortgage) of conveyance. However, certain states, such as Georgia, assess the real property tax at the state level.
In other jurisdictions, different governmental agencies within the same state may assess a transfer tax (e.g., the state, county and/or city) on the same property or transaction. For example, New York City imposes a real estate transfer tax that is separate from the one imposed by the state of New York. The real estate transfer tax in New York City is imposed on each deed at the time of delivery by a grantor to a grantee when the consideration and any improvement thereon exceeds $25,000. It is imposed on the value of the property transferred, and the city tax rate is 1.425 percent if the consideration paid is $500,000 or less, and 2.625 percent if the consideration paid is more than $500,000. In addition to the city tax, New York state imposes a tax on all deeds and transfers of real property, but at a different rate. New York state imposes the tax on 0.40 percent of the consideration paid.
In addition, most jurisdictions require recordation taxes to be paid when the deed is entered into record with the county or state governmental agency. However, the time to pay the tax varies by jurisdiction and to whom the tax is paid varies by jurisdiction. For instance, effective January 1, 2011, Vermont provides that the transfer tax is due to the Vermont Department of Taxes at the time the title of the property is transferred (i.e. the date of closing). A new Property Transfer Payment Voucher (Form PT-173) must accompany all payments to give the parties the proper credit for the transfer tax paid.
Controlling-Interest Transfer Tax
How the transaction is structured will impact the overall real property transfer tax burden. A number of jurisdictions impose a tax on the transfer of an entity’s controlling interest. These include Connecticut, Delaware, District of Columbia, Florida, Illinois, Maine, Maryland, New Hampshire, New Jersey, New York, Pennsylvania and Washington.
So what is a controlling-interest transfer tax? It occurs when a change in beneficial ownership of real property is facilitated, for example, by the stock or interest of a business entity being acquired or sold. Many states look through tiers of beneficial ownership to a lower-level entity that owns such property to determine if control of the entity was transferred. States commonly define control either as “50 percent or more” or as “more than 50 percent,” but it generally means the requisite percentage of ownership of voting stock in a corporation, and the capital or profits or beneficial interest in the entity in other entities.
For example, in Illinois the real estate transfer tax is imposed on the transfer of a controlling interest, which is defined as more than 50 percent of the fair market value of all ownership interests or beneficial interests in a real estate entity. A real estate entity is defined as any person — including any partnership, corporation, limited liability company, trust, other entity, or multi-tiered entity — that exists or acts substantially for the purpose of holding, directly or indirectly, title to or a beneficial interest in real property. Furthermore, Illinois provides that there is rebuttable presumption that an entity is a real estate entity if it owns, directly or indirectly, real property having a fair market value greater than 75 percent of the total fair market value of all the entity's assets, determined without deduction for any mortgage, lien or encumbrance.
It is important to note that local jurisdictions may also impose a controlling-interest transfer tax. For instance, Chicago and New York City have enacted ordinances that impose this tax on the sale of at least 50 percent ownership interest in a corporation, partnership, trust or other entity that owns or leases real property.
Although many states, cities and/or municipalities impose a real property transfer tax on the sale of a controlling interest, certain states may not impose the tax if the owner sells the entity rather than the underlying real property.
Leasehold Interest Transfer Tax
Real property transfer taxes may also be imposed on the conveyance of a leasehold interest. Approximately two-fifths of states have statutes and regulations that impose such tax. The minimum lease term to trigger such a tax varies widely among the states. In Wisconsin and New Jersey, for example, only leases with terms longer than 99 years are subject to leasehold transfer tax. In Massachusetts, however, the tax is levied on all leases regardless of the length of their terms.
Alvarez & Marsal Taxand Says:
Although not the most prominent, real property transfer taxes can have a significant impact on large-scale, multi-state transactions that involve a significant amount of real property. It is important to diligently research the specific details of real property transfer and recordation taxes in the jurisdictions where the real property is located. Don’t forget to identify not only the taxes due at the state level but also at the local levels, especially since the local jurisdictions typically impose the tax at a much higher rate than the state. Transactions that involve controlling interest and/or leasehold interest can also impact the overall transfer tax liability.
While time-consuming, doing adequate research on the real property transfer taxes that may affect a proposed transaction will provide a better estimate of the tax implications and, ultimately, the value of the transaction. It is imperative that sellers and buyers be aware of these taxes at the state, county and/or municipality level in order to avoid any unwanted surprises.
Managing Director, Houston
Emilio E. Martinez, Director, and Andrew Townsell contributed to this article
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