In contrast to the sales tax, which does not apply to a sale of real property or to a sale of equity in a company, the real estate transfer tax does apply to the former and may apply to the latter. In the context of a deal, there may also be other situations in which the tax will be triggered.
The tax is imposed on each conveyance of real property or interest therein, at the rate of $2.00 for each $500 (0.40%) or part thereof, of consideration paid for the conveyance. (In NYC, the rate is 2.625% of the consideration where the consideration is more than $500,000; otherwise, 1.425%.)
The real estate transfer tax is payable by the seller. If the seller fails to pay the tax timely, the buyer must pay the tax; in that case, the tax is the joint and several liability of the seller and the buyer.
Where the buyer agrees to pay the tax as part of the consideration for the conveyance (not an unusual event), the tax is computed on (i) the consideration exclusive of this agreement, plus (ii) the amount of tax computed on the consideration in (i).
It should be noted that all conveyances of real property are presumed taxable. When the consideration includes property other than money, the consideration is deemed to be the FMV of the real property or interest therein.
What is consideration?
In general, “consideration” means the price actually paid or required to be paid for the real property or the interest therein, whether paid or to be paid by money, property, or any other thing of value, including stock in the buyer.
It includes the cancellation or discharge of a debt or obligation, as well as the amount of any mortgage or any encumbrance on the real property, whether or not the underlying indebtedness is assumed or taken subject to.
No exclusion is made by reason of deferred payments of the purchase price, whether represented by notes or otherwise. There is no installment reporting for the transfer tax.
What is a taxable conveyance?
A conveyance includes any sale or exchange of real property, as well as any sale or exchange of any “interest” in real property. An interest in real property includes a title in fee, a leasehold interest, and the transfer of a controlling interest in an entity that has an interest in real property.
The creation of a lease is a taxable conveyance where the sum of the terms (length) of the lease, and any options for renewal, exceeds 49 years, and substantial capital improvements are or may be made for the benefit of the lessee, and the lease is for substantially all (90% or more of the total rentable space, exclusive of common areas) of the premises. The consideration in that case is the present value of the right to receive rental payments, including rental attributable to any renewal terms. The present value is determined using 110% of the mid-term AFR, and the discount rate is applied to “net rents” (taking into account operating costs).
The creation of a lease that is coupled with the granting of an option to purchase the real property (regardless of the lease term) is a taxable conveyance. (This will often occur where the seller retains the real property, either directly or in a related entity.) The consideration in that case is the present value of the rental payments plus the amount paid for the option.
The transfer of an existing leasehold interest (regardless of the remaining lease term), or the granting of an option to buy real property, are both taxable conveyances for which the consideration is the amount paid by the buyer (consideration does not include the present value of the remaining rental payments required to be made). If the lessor pays an amount to the lessee to surrender a lease, the consideration is the amount paid. However, no tax is imposed when the lessee pays the lessor to get out of a lease.
In the case of an entity that has an interest in real property, the transfer or acquisition of a “controlling interest” occurs when a person or group of persons “acting in concert”, transfer or acquire: in the case of a corporation, either 50% or more of the total combined voting power of all classes of stock, or 50% or more of the capital, profits or beneficial interests in such voting stock; and, in the case of a partnership, 50% or more of the capital, profits or beneficial interests in such partnership. (Note that the value of the real property relative to the value of the entity’s other assets is irrelevant. This should be contrasted with FIRPTA, under which a transfer of corporate stock is subject to the FIRPTA tax and withholding only where the corporation is a “U.S. real property holding corporation” — in general, where the corporation’s U.S. real property exceeds 50% of the total fair market value of all of the corporation’s assets.)
In the case of the transfer of a controlling interest in any entity that owns real property, “consideration” means the FMV (gross, not net) of the real property, apportioned based on the percentage of the ownership interest transferred.
By now, you have a sense of the variety of situations, in the context of a deal, that may trigger the real estate transfer tax. The sale of real property in an asset sale, the sale of stock in an entity owning any real property, the assignment of a lease, the creation of a lease, the cancellation of a lease, the granting of an option to buy real property; all these must be considered in determining the exposure to the real estate transfer tax.
While most conveyances are presumed taxable, certain conveyances may not be (at least partially). The most commonly encountered is one involving an income tax-free or partially income tax-free reorganization, or an income-taxable transaction where the seller or its owners accept some equity interest in the buyer in consideration for the transfer of the real property.
Specifically, under this exemption, to the extent that a conveyance effectuates a mere change of identify or form of ownership or organization, and there is no change in beneficial ownership of the underlying real property, the tax does not apply.
Note that a like-kind exchange of real property is a taxable conveyance, even though no income tax is imposed.
Whether or not a tax is due, the seller and buyer must file a joint transfer tax return for each conveyance. If the conveyance is to be recorded (e.g., a deed), the return must be filed with the appropriate county’s recording office; any tax due may also be remitted there.
If the conveyance is not recorded (e.g., a stock sale), the return and tax must be filed with the State.
In either case, the return is due and the tax must be paid no later than the 30th day after the sale.
Both the seller and the buyer are required to sign the returns.
The next post (and the final in this series) will provide some practical considerations regarding the transfer tax.