United States: Distinction Regarding Acquired Real Estate Companies Under Pennsylvania's Realty Transfer Tax Act And Philadelphia's Realty Transfer Tax Act

Pennsylvania's Realty Transfer Tax Act1 and Philadelphia's Realty Transfer Tax Act2 are similar in many respects, however, an important distinction exists with regard to whether a change in ownership interest in a real estate company has occurred for purposes of determining whether a real estate company becomes an "acquired" company subject to realty transfer tax. Counsel for the City of Philadelphia has indicated that Philadelphia will take a position contrary to the position asserted under the Pennsylvania Act and find that transfers between family members of ownership interests in a real estate company are considered a "change in ownership" for purposes of determining whether a real estate company becomes an "acquired" company subject to realty transfer tax under the Philadelphia Act.

Background

Under the Pennsylvania Act, every person who transfers ownership of real estate located in Pennsylvania must pay in connection with the transfer realty transfer tax equal to one percent of the value of the real estate that is being transferred, unless the transfer is excluded from taxation under the Pennsylvania Act.

Under the Philadelphia Act, every person who transfers ownership of real estate located in the City of Philadelphia must pay in connection with the transfer an additional realty transfer tax equal to three percent of the value of the real estate that is being transferred, unless the transfer is excluded from taxation under the Philadelphia Act.

Therefore, a transfer of ownership of real estate located in the City of Philadelphia is potentially subject to realty transfer tax in the amount of four percent of the value of the real estate that is being transferred. Both the transferee and the transferor of the ownership of real estate are jointly liable for the payment of realty transfer tax under the Pennsylvania Act and the Philadelphia Act.

In addition to outright transfers of ownership of real estate, realty transfer tax is imposed in connection with the transfer of ownership interests in a real estate company3 under certain circumstances that cause the real estate company to be considered an "acquired" company and thereby subject to realty transfer tax under the Pennsylvania Act and the Philadelphia Act.

Under both the Pennsylvania Act and the Philadelphia Act, a real estate company becomes an "acquired" company when a "change in ownership interest" in the company, however effected, "(i) does not affect the continuity of the company and (ii) of itself or together with prior changes has the effect of transferring, directly or indirectly, ninety percent or more of the total ownership interest in the company within a period of three years."4 That is, if during any three-year period 90 percent or more of the ownership interests in a real estate company are transferred, whether through one "change in ownership interest" or through several "changes in ownership interests," then the company becomes "acquired" and must pay realty transfer tax on the cumulative value of the ownership interests transferred.

Discussion

Under the Pennsylvania Act, a transfer between members of the same family of an ownership interest in a real estate company is excluded from Pennsylvania's realty transfer tax. Additionally, regulations have been promulgated under the Pennsylvania Act that state that a transfer between members of the same family of an ownership interest in a real estate company is not considered a "change in ownership interest" for purposes of determining whether a real estate company becomes "acquired" and thereby subject to Pennsylvania's realty transfer tax.

For example, if a father who owns 90 percent of the ownership interests in a real estate company transfers all 90 percent of his interests in the real estate company to his daughter or other lineal descendent or ascendant, the transfer would not be subject to realty transfer tax under the Pennsylvania Act because no "change in ownership interest" has occurred, despite the fact that 90 percent of the total ownership interests in the real estate company were transferred.

By promulgating this regulation, the Pennsylvania legislature has taken the position that transfers between members of the same family of an ownership interest in a real estate company are not taxable transfers regardless of the total percentage of ownership interests that are transferred. This reasoning is aligned with Pennsylvania's outright exemption from realty transfer tax of transfers of ownership of real estate between family members owned outright; that is, under the Pennsylvania Act, transfers of ownership of real estate between family members are not taxable transfers regardless of whether the real estate is owned outright or through a real estate company.

Like the Pennsylvania Act, the Philadelphia Act provides that a transfer between members of the same family of an ownership interest in a real estate company is excluded from Philadelphia's realty transfer tax. Unlike Pennsylvania, however, no regulation has been promulgated under the Philadelphia Act that clarifies whether a transfer between family members of an ownership interest in a real estate company qualifies as a "change in the ownership interest" for purposes of determining whether a real estate company has become "acquired" and thereby subject to Philadelphia's realty transfer tax.

No formal opinion on the issue has been handed down by the City of Philadelphia, however, Counsel for the City of Philadelphia has stated that Philadelphia will likely not follow Pennsylvania on the issue.

Therefore, under the Philadelphia Act, if a father owns 90 percent of the interests in a real estate company and transfers 90 percent of his interests in the real estate company to his daughter or other lineal descendant or ascendant, the real estate company would become an "acquired" real estate company and subject Philadelphia's realty transfer tax in the amount of three percent of the value of the real estate that is being transferred.

Similarly, under the Philadelphia Act, a transfer between members of the same family of 90 percent or more of an ownership interest in a real estate company will be subject to Philadelphia's realty transfer tax despite the fact that the transfer of ownership of real estate owned by family members outright would not be subject to Philadelphia's realty transfer tax regardless of the percentage of ownership being transferred. That is, under the Philadelphia Act, transfers of ownership of real estate between family members are taxed differently based on whether the real estate is owned outright or through a real estate company.

This statement by Counsel for the City of Philadelphia has a significant potential impact for owners of real estate companies with real estate located in Philadelphia who are planning on transferring their interests in the real estate companies to family members for business succession or estate planning purposes. This distinction is also an important consideration when deciding whether to purchase real estate located in Philadelphia outright or through a holding company.

Footnotes

[1] 72 P.S. §§ 8101-C et seq.

[2] Phila. Code §§19-4400 et seq.

[3] Under the Pennsylvania Act, a "real estate company" is defined as a corporation, general partnership, limited partnership, limited liability partnership or any other form of unincorporated enterprise owned or conducted by two or more persons other than a private trust or decedent's estate that meets any of the following: "(1) [the company is] primarily engaged in the business of holding, selling or leasing real estate, ninety percent or more of the ownership interest in which is held by thirty-five or fewer persons and which, (i) derives sixty percent or more of its annual gross receipts from the ownership or disposition of real estate; or (ii) holds real estate, the value of which comprises ninety percent or more of the value of its entire tangible asset holdings exclusive of tangible assets which are freely transferable and actively traded on an established market; or (2) ninety percent or more of the ownership interest in [a company] is held by thirty-five or fewer persons, and [the company] owns, as ninety percent or more of the fair market value of its assets, a direct or indirect interest in a real estate company. An indirect ownership interest is an interest in [a company], ninety percent or more of the ownership interest which is held by thirty-five or fewer persons whose purpose is the ownership of a real estate company." 72 P.S. § 8101-C (emphasis added).

Under the Philadelphia Act, a "real estate company" is similarly defined as a corporation, general partnership, limited partnership, limited liability partnership or any other form of unincorporated enterprise owned or conducted by two or more persons other than a private trust or decedent's estate that meets any of the following: "(1) [the company is] primarily engaged in the business of holding, selling or leasing real estate, ninety percent or more of the ownership interest in which is held by thirty-five or fewer persons and which, (i) derives sixty percent or more of its annual gross receipts from the ownership or disposition of real estate; or (ii) holds real estate, the value of which comprises fifty percent or more of the value of its entire tangible asset holdings exclusive of tangible assets which are freely transferable and actively traded on an established market; or (2) [a company] which holds, directly or indirectly, as ninety percent or more of the value of its assets, an interest in a real estate company." Phila. Code § 19-1402(11) (emphasis added).

[4] 72 P.S. § 8102-C.5(a); Phila. Code § 19-1407 (emphasis added).

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