United States: California Holds Documentary Transfer Tax Can Apply To Transfers Of Interests In Legal Entities That Own Real Estate

 On June 29, 2017, the California Supreme Court held that the documentary transfer tax may apply to transfers of interests in legal entities that own real estate.1 Specifically, the Court held that the documentary transfer tax may be imposed when a transfer of a legal entity results in a change in ownership of real property within the meaning of Cal. Rev. & Tax. Code Sec. 64(c) or (d). The decision by the Court is notable not only for extending the application of the documentary transfer tax beyond "ordinary sales of real property," but also for incorporating the concept of "change in ownership" from the state's property tax system into the documentary transfer tax system.


Beryl and Gloria Averbook owned an apartment building at 926 North Ardmore Avenue in Los Angeles, California (the Building) which they transferred into a family trust in 1972. After Beryl's death in 2007, the assets of the family trust were transferred into an administrative trust of which Gloria was the beneficiary and Bruce and Allen Averbook, Gloria's sons, were the successor trustees. The sons formed 926 North Ardmore Avenue, LLC (LLC), a single-member limited liability company and BA Realty, LLLP (BA Realty), a partnership. The administrative trust was the sole member of LLC and held a 99 percent partnership interest in BA Realty.

In 2008, the administrative trust conveyed the Building by grant deed to LLC and transferred its membership interest in LLC to BA Realty. The administrative trust then distributed its 99 percent interest in BA Realty to four subtrusts that were maintained for the benefit of Gloria. In 2009, three of the subtrusts transferred their BA Realty interests to two trusts maintained for the sons (Allen and Bruce Trusts) through written agreements, none of which mentioned the Building or its location. The agreements were not recorded and the transfer did not include the execution of any deed or other instrument transferring title to the Building.2 After the 2009 transaction, the Allen and Bruce Trusts each held a 44.595 percent partnership interest in BA Realty, which was the sole member of LLC, which still held legal title to the Building.

In 2011, the Los Angeles County registrar-recorder issued a county documentary transfer tax assessment notice to LLC. The documentary transfer tax was assessed, according to the county recorder, because the Building had undergone a change in ownership in 2009. LLC paid the transfer tax and then filed a claim for refund. The refund claim was denied by the trial court and the decision was affirmed by the California Court of Appeal.

California's Documentary Transfer Tax Act

Cal. Rev. & Tax. Code Sec. 11911, which is part of the Documentary Transfer Tax Act,3 allows California counties to levy a tax "on each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers," if "the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale)" exceeds $100.4 The core issue in the case focused on whether this provision allowed for the documentary transfer tax to be applied to the transfer of an interest in a legal entity.

LLC argued that the tax could not be imposed on a written instrument that transfers an interest in a legal entity, even if the entity owns real property, unless the instrument directly references or shows the location of the realty. Because LLC transferred interests in BA Realty and did not refer to the Building or its location, it argued that the documents were not subject to the tax. In contrast, the county argued that Sec. 11911 authorizes a tax on any instrument by which an interest in real property is sold, whether directly by a deed, or indirectly, as part of a transaction involving the transfer of a legal entity.

Written Instrument Not Required to Directly Reference Real Property

Acknowledging that Sec. 11911 could be read to support either party's reading of the statute, the Court ultimately rejected LLC's argument because it was "undermined" by another section of the Act, Cal. Rev. & Tax. Code Sec. 11925. This section creates a conditional exemption from the documentary transfer tax for realty held by certain entities when interests in those entities are transferred. According to the Court, this "exemption . . . would be unnecessary if entity interest transfers did not trigger the documentary transfer tax as a general matter."

Next, LLC pointed to other sections of the Act which: (1) require that any document subject to the tax include the tax roll parcel number of the property conveyed;5 (2) require that every document subject to the tax and submitted for recording show the location of the lands, tenements, or other realty described in the document;6 and (3) prohibit the recording of any document subject to the tax unless the tax has been paid.7 LLC argued that each of these provisions shows that the tax does not apply to a written instrument conveying legal entity interests because, typically, these instruments would not show the property's parcel number or location, and would not be recorded. Furthermore, the tax logistically could not be imposed on unrecorded documents because the Act provides no mechanism for tax collection when a written instrument is not recorded.

The Court rejected these arguments, noting that the provisions cited by LLC do not operate to limit the scope of the documentary transfer tax. These provisions impose requirements for documents submitted for recording, but do not necessarily apply to documents that are not submitted for recording. For example, the requirement that any document subject to the tax include the tax roll parcel number does not mean that only documents showing that number are subject to the tax. The Court noted that this construction would be absurd because it would allow parties to avoid the tax simply by omitting the number from the document. Based on this reasoning, the Court held that a written instrument conveying an interest in a legal entity that owns real property may be taxable, even if the instrument does not directly reference the real property and is not recorded.

Adoption of Property Tax Change in Ownership Rules

Having established the scope of the documentary transfer tax, the Court turned to the issue of when the tax is triggered. The Court explained that, in 2010, legislation was enacted that required county assessors to share information contained in the change in ownership statements filed with the California State Board of Equalization with county recorders. As a result, the Los Angeles county recorder began "routinely assessing the transfer tax whenever a change in control of a legal entity resulted in a change in ownership of real property." LLC argued that this reliance on the change of ownership rules contained in the property tax system could not be carried over to the documentary transfer tax system. The Court disagreed.

Based on a review of federal cases that applied "the federal stamp act in the context of corporate transactions,"8 the Court explained that the critical factor in determining whether the documentary transfer tax may be imposed is whether there is a sale that results in a transfer of beneficial ownership of real property. According to the Court, the change in ownership rules were "designed to identify precisely the types of indirect real property transfers that the Transfer Tax Act is designed to tax." The Court noted that, under California's property tax laws, a '"change in ownership' of real property occurs when there is 'a transfer of a present interest in real property, including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.'"9 This statute plays a "central role" in the state's property tax system because a change in ownership triggers reappraisal and reassessment for property tax purposes.10

The Court explained that while a transfer of an interest in a legal entity generally does not result in a change in ownership of the entity's real property,11 there are exceptions to this rule.12 Specifically, the statute provides that a change in ownership of all real property owned by a legal entity results when (1) the property was previously transferred to that entity, but that transfer is not deemed to be a change in ownership under Cal. Rev. & Tax. Code Sec. 64(a) and (2) shares or interests representing more than 50 percent of the total interests in the entity are subsequently transferred by any of the original co-owners in one or more transactions.13 Adopting this concept, the Court held that Sec. 11911 allows the documentary transfer tax to be imposed when a transfer of an interest in a legal entity results in a change in ownership of real property within the meaning of Cal. Rev. & Tax. Code Sec. 64(c) or (d), as long as there is a written instrument reflecting a sale of the property for consideration.

Significant Expansion of Documentary Transfer Tax

In a dissenting opinion, one of the Court's justices found the majority opinion troubling because it reflected the Court's impermissible expansion of the documentary transfer tax to "run-of-the-mill transfers of interests in legal entities that happen to own real estate." The dissent focuses on the fact that the tax authorized by the Act applies to "'deed[s]' or other 'writing[s]' by which land or other real property is conveyed for value." Specifically, the dissent argues that Sec. 11911 is silent on taxing entity interest transfers. Rather, Sec. 11911, along with the federal statute on which it was modeled, has only been applied to documents that directly convey interests in real property for consideration. According to the dissent, the majority decision holds that the Act applies to a document by which entity interests are transferred, for consideration, if the transaction results in a transfer of beneficial ownership of real property. Effectively, this holding makes the Act applicable to "a considerable swath of entity interest transfers that bear little or no resemblance to ordinary sales of real property."

According to the dissent, one of the most problematic aspects of the decision is that it applies the property tax law's change in ownership framework in the documentary transfer tax context. Irrespective of whether this is "a good idea," the ability to do so, according to the dissent, does not fall within the purview of the courts.14 As stated by the dissent, the Court's expansion of the tax goes against the "statute's language and historical practice" and encroaches on the legislature's role to determine the "circumstances under which an entity interest transfer should result in a deemed sale of the entity's real estate."


Contrary to the "form over substance" interpretation of real estate transfer taxes historically taken in many states with respect to the treatment of intercompany or interfamily real estate transactions, the Court determined that applying "substance over form" principles in this case was necessary. The dissenting justice agreed that a substance over form approach may have been tenable, but in this instance, where the transaction was "bona fide, completed for legitimate reasons, and had economic substance," applying the documentary transfer tax reached beyond a pure "substance over form" analysis. The approach highlighted by the majority of the Court could serve as a template for other states to eventually follow with respect to their real estate transfer tax laws.

This case has generated a substantial amount of interest15 in California because of its significant implications for transactions involving mergers and acquisitions, which are often considered during the due diligence process performed by purchasers and sellers prior to closing. In essence, the Court's decision is tantamount to an expansion of the documentary transfer tax base that now encompasses "a whole new class of transactions – sales of interests in business entities that own real property."16 As a result, the decision has the potential to impact any entity acquisition where the entity owns California real estate, as well as other transactions in which the majority of a beneficial interest in real estate property changes from one individual or business to another (through technical terminations or other means).


1 926 North Ardmore Avenue, LLC v. County of Los Angeles, California Supreme Court, No. S222329, June. 29, 2017. Note that the taxpayer filed a rehearing petition on July 13, 2017.

2 The Allen and Bruce Trusts executed promissory notes to Gloria's three subtrusts as consideration for the transferred interests.

3 CAL. REV. & TAX. CODE § 11901 et seq.

4 CAL. REV. & TAX. CODE § 11911(a).

5 CAL. REV. & TAX. CODE § 11911.1.

6 CAL. REV. & TAX. CODE § 11932.

7 CAL. REV. & TAX. CODE § 11933.

8 CAL. REV. & TAX. CODE § 11911 is derived from a provision of the former federal documentary stamp act.

9 CAL. REV. & TAX. CODE § 60.

10 CAL. CONST., ART. XIII A, § 2.

11 CAL. REV. & TAX. CODE § 64(a).

12 CAL. REV. & TAX. CODE § 64(c), (d).

13 CAL. REV. & TAX. CODE § 64(d).

14 The dissent noted that at least one bill had been put forth to incorporate the property tax law's change in ownership rules into the Act. Citing to A.B. 561 (2013–2014 Reg. Sess.) § 1.

15 Amicus briefs were filed in support of the taxpayer by many organizations, including the Council on State Taxation.

16 Application for Permission to File Amicus Curiae Brief and Brief of Amicus Curiae, Council on State Taxation in Support of Plaintiff and Appellant, Council on State Taxation, Oct. 2, 2015.

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