There was a time when closing a real estate sale cost the seller a few hundred dollars for transfer tax stamps on the transfer deed, but those days are long gone. Nowadays, transfer tax can be a major consideration in structuring and funding a property transaction. And the requirements for complying with, or being excluded from, transfer taxes have multiplied.
In some markets, transfer tax can exceed the property tax burden in the first few years after an acquisition. For example, in San Francisco the transfer tax on property transactions valued at more than $10 million is 2.5 percent of the sales price.
Transfer tax scope widens
Historically, transfer taxes were only collected when the county recorder’s office recorded a deed. If a transfer occurred through the acquisition of a legal entity that owned the property, and that entity continued to exist without requiring a transfer deed, then no transfer tax was owed.
Today, however, many real estate transactions occur through the buying or selling of ownership interests in legal entities which hold title to real property, and which continue to exist and hold property after the transaction has concluded. Technically, there is an indirect change in ownership because the legal entity is now owned by a different entity or owner, even though the title for the real estate remains unchanged.
The proliferation of these indirect property transfers has spurred tax authorities to enact laws that assess transfer taxes on indirect sales. The deed-recording process cannot capture indirect sales, so counties and cities now require buyers and/or sellers to report such transfers through other means.
The most common way of tracking indirect transfers is to align transfer tax reporting with the property tax system. In California, for example, taxpayers must report legal entity transfers to the state Board of Equalization, which in turn reports the transfers to county assessors. Counties and cities which collect transfer taxes on indirect sales can now access assessor databases to learn about indirect transfers in their jurisdictions.
Fewer exclusions, a patchwork of requirements
Most transfer tax laws contain numerous exclusions. For example, if there is a mortgage against a property, the amount financed is excluded from the purchase price when calculating the transfer tax. Similarly, transfers of property between entities which have the same ownership percentages are excluded from transfer taxes. A third example is the exclusion from transfer tax for marital dissolutions.
In recent years, however, tax authorities have repealed some exclusions from transfer tax. Some jurisdictions have deleted the mortgage deduction. Likewise, gifts and transfers upon death, and transfers to non-profit entities, which were once generally excluded, are now subject to transfer tax.
The declining number of exclusions restricts a market participant’s ability to structure transactions to be exempt from transfer tax. That task has grown only more difficult as variations in tax rules have increased between jurisdictions at the local level.
The transfer tax has traditionally been and continues to be a local tax. Consequently, individual counties and cities determine what elements to include or not include in their transfer tax ordinances. Transfer taxes are an attractive way for local governments to raise revenue, particularly when other sources of tax income are limited.
In California, most counties and cities operate under the traditional transfer tax laws that the state Legislature established almost 50 years ago. But more than a dozen counties and cities have modified the transfer tax law enacted by the Legislature. The courts have approved such changes under the home rule doctrine, which allows communities to govern themselves with laws that don’t conflict with state or federal law.
These modifications have two primary goals: The first is to impose transfer tax on indirect transfers of real property caused by changes in the ownership of legal entities. The second goal is to repeal the exclusions that existed in the original transfer tax laws. In addition, the modifications have often added penalties for failure to pay transfer taxes.
California, like most states, has dozens of counties and hundreds of cities, which means that buyers and sellers of real property must familiarize themselves with the specific provisions in local transfer tax ordinances.
Transfer tax compliance used to be as simple as checking a box. But high transfer tax rates, the prevalence of indirect property sales and rising property values have increased the significance and complexity of transfer taxes in property transactions. Awareness of tax rates, available exclusions from the transfer tax and compliance and reporting requirements is essential to maximize property value and avoiding reporting pitfalls.
Cris K. O’Neall, a shareholder at the law firm Greenberg Traurig,LLP, focuses his practice on ad valorem property tax assessment counseling and litigation. The firm is the California member of the American Property Tax Counsel, the national affiliation of property tax attorneys. Cris O’Neall can be reached at [email protected].