Controlling interest provisions in state and local real estate transfer taxes.

• Author: Dennis, Donald R.

Approximately two-thirds of U.S. states, as well as a number of municipalities, counties, and other units of local government, impose a tax on taxpayers when they transfer real property to another party. As a practical matter, a real property transfer tax is typically triggered if a deed is recorded. One of the most common ways for a taxpayer to transfer real estate to a new owner without recording a deed is through the transfer of an ownership interest in an entity that holds title to the property. Given such a loophole, it is small wonder that taxpayers have created entities and engineered transactions in order to avoid this tax.

Beginning with the example of New York in 1986, a number of jurisdictions that imposed a transfer tax now require taxpayers who engage in these types of transfers to pay the tax. The imposition of tax occurs when the transfer is deemed to be an indirect transfer of ownership in real property, even if a deed was not recorded. The jurisdictions that have adopted this approach treat transfers of a controlling interest in a legal entity, such as a corporation and the like, as taxable transfers of real property.

A taxpayer is often deemed to have transferred a controlling interest if more than 50% of the ownership interest in the legal entity is transferred to a new owner. The list of legal entities is usually inclusive and includes trusts and single-member limited liability companies (SMLLCs). Because there is no reference to federal income tax concepts in these statutes, practitioners who are used to treating entities as disregarded for federal income tax purposes are required to regard them for purposes of applying these concepts.

Two Approaches to the Controlling Interest Concept

In most cases, the states that have adopted a controlling interest concept take one of two approaches for determining whether a transfer of a controlling interest represents a taxable conveyance of real property.

States like New York that take a broad approach generally tax transfers of a controlling interest in an entity that owns in-state property. Certain jurisdictions assess transfer tax based on the percentage of the ultimate change in ownership of the underlying real property, while other states that adopt this approach impose tax on 100% of the property's value regardless of whether there is only a partial change in beneficial ownership of the underlying real property. In consequence, jurisdictions that adopt this approach can and...