The obligation to pay state and local real estate transfer taxes on the sale of commercial real estate is a significant, yet often overlooked, cost of real estate transactions.
Traditionally real estate transfer taxes were paid when a new deed was presented to the county recorder. To avoid the real estate transfer tax, which can be more than 4% of the sale price, in some cases the real property was transferred to a corporate or partnership entity. When the ownership interest in the entity that owned real estate was sold, the real estate transfer tax did not apply to the transaction.
As the states became aware of this legal loophole to avoid the payment of the transfer tax, they expanded their real estate transfer tax laws to impose the tax on sales of ownership interests in entities that directly or indirectly include the transfer of real estate. These taxes are commonly known as controlling interest transfer taxes (CITT).
As a deed is not filed when ownership of real property is transferred after the sale of an entity, when completing stock acquisitions, or other mergers or reorganizations, the CITT may be overlooked. Even if a merger qualifies as a tax-deferred reorganization under the federal tax code, state or local transfer taxes may be imposed if the stock transferred represents ownership in an entity holding real estate, and no exemption is available.
Currently, 17 states either impose or allow municipalities to impose such taxes: Connecticut, Maine, Washington, the District of Columbia, Maryland, Michigan, New Hampshire, Delaware, California, New Jersey, New York, Florida, Minnesota, Illinois, Pennsylvania, Rhode Island and Vermont. At the same time, 38 states impose a real estate transfer tax; thus, it is possible that additional states may add the CITT in the future.
The laws generally provide that CITT applies to “a transfer or acquisition of a controlling interest in any entity with title to property located in the state or local jurisdiction”. The tax rate is applied to the value of the property transferred, which is the fair market value of the property apportioned by the percentage of the ownership interest transferred. Depending on state laws, some transfers between related entities may be exempt from the CITT.
For more information on the application of CITT to a specific transaction, please feel free to contact me
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