Controlling-Interest Real Estate Transfer Taxes: The Potential State Tax Trap in Mergers and Acquisitions MICHELE RANDALL AND JOSEPH GURNEY (Vol. 888, No. 3) 1 Analysis&Perspective Tax Base With the upswing in merger and acquisition activity comes concern about the obligation to pay state and local real estate transfer taxes, often overlooked during the complex M&A process. Authors Michele Randall and Joseph Gurney of Deloitte Tax LLP provide an over- view of the state taxing regimes applied to controlling-interest real estate transfers, high- light nuances of each state’s rules, point out pitfalls, and describe emerging trends in controlling-interest transfer taxes. Controlling-Interest Real Estate Transfer Taxes: The Potential State Tax Trap in Mergers and Acquisitions BY MICHELE RANDALL AND JOSEPH GURNEY effected transfers of real property, there is often a mis- conception that real estate transfer taxes do not apply. However, depending on the law of the applicable taxing I. Introduction jurisdiction, a merger or other change in control of a le- gal entity can result in imposition of these taxes in the s merger and acquisition activity appears once same way as the outright sale of a company’s real estate again on the upswing in the United States, the im- assets. A position of state and local real estate transfer taxes Generally, a transfer tax is imposed on documents on these transactions remains a significant yet poten- that convey an interest in real property from one person tially overlooked cost. Because corporate mergers and or legal entity to another person or legal entity. The fed- acquisitions generally do not involve direct, deed- eral government imposed a documentary stamp tax on transfers of real property deeds until the tax was re- pealed in 1967. After the federal documentary stamp Michele Randall and Joseph Gurney are tax was repealed, states began to enact their own laws Directors with Deloitte Tax LLP’s Multistate to impose transfer taxes on real estate transfers. Practice, resident in Chicago. Randall, a CPA, holds a B.S. degree in accounting from the University of Illinois-Urbana, Champaign, and a M.S.T. from DePaul University. Gurney Unwary taxpayers may find themselves holds a B.S. degree in accounting from the University of Illinois-Urbana, Champaign. The unexpectedly paying significant tax on transfers authors can be contacted at micrandall@ deloitte.com and [email protected]. The that they never imagined would be subject to authors would like to acknowledge Mike San- toro, Senior Manager, and Fred Paladino, taxation. Director, both with Deloitte Tax LLP, Wash- ington National Tax-Multistate, for their tech- nical and editorial assistance in the prepa- Many states have patterned their taxes after the fed- ration of this article. eral documentary stamp tax. Historically, state transfer This article, including the appendix, does not taxes generally have been imposed on the recordation constitute tax, legal, or other advice from of a deed and are based on the consideration paid or Deloitte Tax LLP, which assumes no responsi- fair market value of the property. However, the state bility with respect to assessing or advising the laws and tax rates can vary greatly across taxing juris- reader as to tax, legal, or other consequences dictions. arising from the reader’s particular situation. In recent years, some states have expanded their Copyright ௠ 2011 Deloitte Development LLC. transfer tax laws to impose tax on transfers of an own- All rights reserved. ership interest in an entity that directly or indirectly owns real estate (rather than imposing tax only when BNA TAX 2 (Vol. 888, No. 3) ANALYSIS & PERSPECTIVE the real estate itself is transferred). Such taxes are com- However, some jurisdictions base the tax on the prop- monly known as ‘‘controlling-interest transfer taxes.’’ erty value, including conveyances where there is no or In contrast to the relative simplicity and uniformity nominal consideration. Typically, the value of a prop- of a traditional transfer tax regime, controlling-interest erty is the price the buyer is willing to pay. This would transfer taxes can be more complex, with each state be the purchase price of the real property as agreed that imposes such a tax taking a different approach to upon in a purchase contract. determining the types of transfers subject to tax. Be- Most states that impose a transfer tax on controlling- cause the characteristics of controlling-interest transfer interest transactions do so based upon the ‘‘fair market tax laws can vary from state to state, unwary taxpayers value’’ of the real estate within the transferred entity. may find themselves unexpectedly paying significant However, unlike the sale of a real property asset, when tax on transfers that they never imagined would be sub- an entity is acquired there may not be a specific identi- ject to taxation, such as mergers or acquisitions involv- fication of real property values in the purchase contract. ing publicly traded companies. This article provides an overview of the various state taxing regimes that impose controlling-interest transfer taxes, highlights some of the nuances of each state’s When an entity is acquired there may not be a rules, provides some common pitfalls associated with such taxes, and describes emerging trends. specific identification of real property values in the II. Overview of Real Estate purchase contract. Transfer Taxes To give perspective and context to emerging Few states address this issue specifically, which can controlling-interest transfer taxes, it is helpful to com- create ambiguity regarding how to determine fair mar- pare their fundamental elements with those of tradi- ket value of the acquired entity’s real property (particu- tional, deed-triggered real estate transfer taxes. As larly when the entity owns other assets such as tangible states have added controlling-interest transfer tax pro- personal property or intangible property). Washington visions to existing real estate transfer tax regimes, the state provides that when ‘‘the total consideration for the change has not always been accompanied by sufficient sale cannot be ascertained or the true and fair value of guidance or interpretation to account for the unique the property to be valued at the time of sale cannot rea- facts of a controlling interest transfer. sonably be determined, the market value assessment for the property maintained on the county property tax A. Similarities in Administration rolls at the time of the sale shall be used as the selling price.’’3 In contrast, the tax base in Delaware is gener- Some form of real estate transfer tax is imposed in ally the greater of consideration or appraised value, un- 39 states at a state, county, or city level.1 Many states less it is established that the fair market value is less that have a transfer tax impose the tax at the state level than the appraised value in which case it is the greater and have the county recorder of deeds collect the tax of fair market value or consideration.4 Unfortunately, and remit it to the state when a deed is recorded. Other most states are silent regarding how to determine the states mandate a statewide rate but permit the counties tax base for controlled-interest transfers. to retain the taxes collected. Some local jurisdictions Other variations on the question of how the tax base have the authority to enact their own transfer tax rules is to be determined arise in New Jersey and Pennsylva- that can apply even where no such tax is imposed at the nia. Generally, both states impose their real property state level.2 Typically, the local rules conform to the transfer tax on deeds measured by actual consider- state rules (where applicable), but certain local jurisdic- ation.5 However, in the case of an entity transfer, Penn- tions are authorized to enact their own rules that can be sylvania imposes its tax on the actual monetary worth broader than those of the state and sometimes are im- of the real estate determined by adjusting the property’s posed at a significantly higher rate. assessed value by the common level ratio used for local In some cases, a controlling-interest transfer tax is property tax purposes.6 When a transferred entity owns administered in the same or similar manner as the ju- certain classified real property and property other than risdiction’s real estate transfer tax. However, often there are differences in the way the controlling-interest tax is reported to the state since a deed will not be filed 3 Wash. Rev. Code §82.45.030(4). to report the purchase of real estate to the county re- 4 Del. Code Ann. tit. 30, §5401(3). (‘‘ ‘Value’ means . the corder. Controlling-interest transfers typically require a amount of the actual consideration . provided, that in the tax return to be filed with the appropriate jurisdiction to case of a transfer for an amount less than the highest ap- report the change in control and remit the tax. praised full value of said property for local real property tax purposes, ‘value’ shall mean the highest such appraised value unless the parties or one of them can demonstrate that fair B. Transfer Tax Base market value is less than the highest appraised value, in which case ‘value’ shall mean fair market value, or actual consider- Most jurisdictions base the real estate transfer tax on ation, whichever is greater. A demonstration that the transac- the consideration paid for the conveyed real estate. tion was at arm’s length between unrelated parties shall be suf- ficient to demonstrate that the transaction was at fair market value.’’) 1 See Appendix A. 5 Pa. Cons. Stat. §8101-C; Pa. Cons. Stat. §8102-C; N.J.