I’ve addressed real estate transfer tax traps before (February 21, 2017, July 11, 2016, October 12, 2015, October 5, 2015) and the concept of the controlling interest transfer. Simply put, state real property transfer taxes used to be simple; if you transferred title to the property, the tax applied. Life got more complicated and taxpayers got smarter. What about the sale of a business that owns real property? If the buyer were to purchase the existing business entity, the deed stays in the name of the existing business and no transfer tax would apply. Clever property owners came up with the idea to put the property in a special purpose entity specifically to hold title to the property they wished to sell. The buyer would purchase the entity, real property and all. Under the old simplistic transfer tax statutes, the tax wouldn’t apply.
Many, but not all states have come up with some variation of the controlling interest transfer concept. Generally speaking, where 50% (or more than 50%) of an entity that owns real property is transferred within a specified amount of time, the transaction will be viewed as if the property itself has been sold (in the applicable percentage) and the tax will apply.
Now picture this. You have such a transaction in the State of California. A very valuable commercial property is transferred to a new buyer through the sale of most or all of a partnership that has title to that real property. The applicable California statute appears to give local jurisdictions the ability to apply a controlling interest type taxing authority where the entity has been deemed to terminate under federal tax law. It seems clear that the jurisdiction your property is in has adopted the provision. Yet when you go to the County Clerk’s office with your tax return and check you get a puzzled look.
When these provisions were first enacted, many a California County Clerk didn’t know the controlling interest concept existed. If a deed wasn’t being recorded, they wouldn’t take your money. Now this seems like a good thing, right? Well maybe. Individuals and closely held businesses were often happy to keep the money, but many a public company having to report to their shareholders didn’t know what to do.
Even though many counties have caught up with the current state of their law, apparently it took a California Supreme Court decision1 to wake all parties involved to the transfer tax applying when beneficial ownership of a legal entity has changed. When doing a deal in California, chances are that your local County Clerk is going to be aware you owe him some money.
If you have questions about the real estate transfer tax and the controlling interest concept, I can be reached at WBerkowitz@BerdonLLP.com or contact your Berdon advisor.
Wayne Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, advises on the unique requirements of governments and municipalities across the nation.
1 926 North Ardmore Avenue, LLC v. County of Los Angeles (June 29, 2017).