Immediately before the December 15, 2007, effective date of the Pennsylvania Department of Revenue's instantly notorious amended Realty Transfer Tax Regulations, the Department issued a brief "Special Edition Tax Update," Number 131, December 2007. The Update was intended to reassure taxpayers regarding the realty transfer tax implications of assignments of contracts to purchase real estate, and like-kind exchanges of real estate. Indeed, it stated: "[t]he amendments are not intended to create a greater tax burden for Pennsylvanians or enhance revenues."
On January 4, 2008, the Department issued Realty Transfer Tax Bulletin 2008-1, a 13-page collection of scenarios that it believes provide more detailed guidance on the assignment of contract and like-kind exchange issues. (It can be found online by clicking here.) Unfortunately, this Bulletin actually muddies the waters regarding contract assignments, and while its position on like-kind exchanges is somewhat helpful, the rules applicable to exchanges remain a trap for the unwary.
Assignment Of Contracts
The amended regulations provide that in certain cases, the Department will recharacterize an assignment of a contract to purchase real estate as a series of taxable transfers. For example, if Owner contracts to sell its real estate to Partnership A for $1,000,000 and Partnership A assigns that contract to Partnership B for $500,000, when Partnership B buys the property from Owner for $1,000,000, the Department will treat this transaction as if Partnership A bought the property from Owner for $1,000,000 and then sold it to Partnership B for $1,500,000. The Department would impose transfer taxes on both transactions for deemed and actual consideration (totaling $1,500,000). The regulations addressing this issue are unclear, confusing, and contrary to the Pennsylvania Supreme Court's decision in the Allebach case (that held that in this example only $1,000,000 would be subject to transfer tax).
The Department always has been dissatisfied with the Allebach holding because, although the law dictates the result reached by the Supreme Court, the full fair market value of the real estate transferred is not subject to realty transfer tax. However, the amended regulations cover far more than the Allebach facts that the Department finds so offensive. Now, the Department seeks to impose multiple taxes where there is a single payment and, where before the effective date of the amended regulations, realty transfer tax would have been paid only on the full amount of that payment. Notwithstanding the Department's reassurance in its December Tax Update1 with respect to assignments of contracts, the Bulletin leaves very unclear exactly when an assignment of a contract to purchase real estate triggers multiple taxable transfers. Instead of confirming the promised clarity of the Update, the Bulletin explains that the Department instead will apply an ad hoc facts-and-circumstances test that leaves taxpayers with no certainty or assurance.
A disturbing example of that uncertainty is the Department's analysis of the realty transfer tax consequences of the assignment of contracts among affiliated business entities. The Bulletin states that a person cannot be an agent for an entity that does not yet exist. As a result, an entity signing a contract for sale with the intention of assigning it to a to-be-organized entity is not the agent of that entity. Yet this is the typical practice in the real world. A parent company, or a direct or indirect wholly owned affiliate, enters into an agreement of sale. When the parent company is confident that the closing will occur, it organizes an entity to take title, and assigns the agreement of sale to the new entity. In every variation of this common situation, there is a risk that the Department will deem that multiple transfers have occurred that each are subject to realty transfer tax.
The Bulletin offers, as another example, an unsophisticated buyer who enters into an agreement in his own name, and then goes to a lawyer who explains the prudence of taking title in an entity to limit liability. If the buyer creates a wholly owned entity and assigns the agreement to that entity, without consideration, the Department would impose two transfer taxes; one on a deemed purchase by the buyer and another on a deemed contribution of the real estate by the buyer to his new entity.
Until the law becomes clearer, rulings should be sought from the Department.
Like-Kind Exchanges
The new regulations include a provision stating that neither a qualified intermediary ("QI") nor an exchange accommodation titleholder ("EAT") is the agent of the taxpayer. That provision, combined with the uncertain tax consequences of an assignment of contract for sale, raised the specter of multiple realty transfer taxes in connection with like-kind exchanges.
The Bulletin clarifies that in a forward exchange, where the QI does not take title to the real estate, there only are two transfer taxes; one transfer tax on the sale of the relinquished property and another on the purchase of the replacement property. However, in a reverse exchange, the Department treats the EAT as acquiring and transferring the replacement property, resulting in two transfer taxes. If the EAT acquires the replacement property through a tiered disregarded entity structure and transfers all of the interests of the upper tier disregarded entity to the taxpayer, only one transfer tax will be imposed. Thus, as in the earlier example of the unsophisticated buyer, informed taxpayers will pay less tax than the uninformed, a boon for lawyers perhaps, but not for taxpayers.
Footnotes
1. In the Update, the Department posed the following question and answer:
"Question #3 - Will the regulation subject an assignment of a real estate contract to tax, such as an intra-company assignment of a sale contract (i.e., a transfer of an agreement between 100 percent directly or indirectly commonly owned entities)?
Response - No. The Department has never sought to impose tax on an 'intra-company assignment of a sale contract' when one business entity in a corporate structure acts as a facilitator or intermediary for the benefit of another business entity in the corporate structure in a real estate acquisition, assigning a sale contract for no or nominal consideration. The amended regulations do not seek to impose tax on such transactions..."
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