DON'T TRANSFER THAT INTEREST! HOW THE "MERE CHANGE EXEMPTION" PROVIDES LITTLE RELIEF TO TAXPAYERS.

• Author: Greenberg, Eric J.
• Position: ARTICLES

During the past several years, after experiencing the effects of a recession and a severe industry downturn, real estate owners are finally starting to see some relief in real estate values. (1) That being said, the economic outlook for real estate owners is not all positive, highlighted by the fact that realty transfer taxes continue to grow in scope and complexity. (2) Considering the increase in real estate values, the economic cost of realty transfer taxes can be significant, further evidenced by the fact that they are generally imposed on total consideration and/or fair market value ("FMV") rather than gain, and are therefore imposed whether or not the seller even realizes a gain. (3)

Another interesting development is the taxation of conveyances of controlling economic interests in real property. Several states now impose realty transfer taxes on the sale or transfer of controlling interests in corporations, partnerships, or trusts that own real property. (4) These laws were adopted to prevent tax evasion by eliminating the possibility of structuring a transfer of realty as a sale of corporate stock, a partnership interest or a trust interest. (5) While the law is successful in reducing opportunities for taxpayers to otherwise avoid the tax through such transactions, (6) these laws have created an additional layer of rules, regulations and filings for which buyers and sellers of realty must be aware. As a result, many buyers and sellers who are uninformed or not properly represented in such transactions may very well subject themselves to significant unforeseen tax burdens.

This article will look to explore the current standing of the real estate transfer tax ("RETT") in New York and its potential negative effects on unsuspecting taxpayers. Part II of this article will provide the context of the current law in New York. Part III will present a hypothetical transaction and analyze how the holding in In re Petitions of Chase Manhattan Corporation (7) affects the outcome. Part III will also consider whether Chase was the proper application of the Step Transaction Doctrine as well as whether this holding creates a "Lock-In Effect" on future realty transfers. Finally, Part IV will offer a recommendation to try and minimize the potentially unforeseen tax burdens to taxpayers.

2. BACKGROUND OF THE REAL ESTATE TRANSFER TAX IN NEW YORK

   Initially, the New York RETT, effective August 1, 1968, (8) was substantially similar to the prior federal documentary stamp tax on realty transfers. (9) In 1989, it was extended to transfers of economic interests in real estate by L. 1989, c. 61. (10) Subsections A & B of this section discuss the current standing of the law and how it is applied to real estate transfers.

   1. New York State Real Estate Transfer Tax ("RETT")

      1. Determination of New York State Real Estate Transfer Tax

         Under New York Tax Law [section]1402(a), a state real estate transfer tax is imposed "on each conveyance of real property or interest therein." (11) The New York State RETT is imposed at a 0.4 percent rate (12) on direct transfers of real estate, indirect transfers/acquisitions of either 50 percent or more of the total combined voting power of all classes of stock of a corporation which has an interest in New York real property, (13) or 50 percent or more of the capital, profits, or beneficial interests in such voting stock of such corporation. (14) In the case of a partnership, association, trust or other entity, New York imposes the same tax on transfers of 50 percent or more of the capital, profits or beneficial interests in such entities. (15) New York State may aggregate multiple transfers if the parties are acting in concert or if they occur within a three year period. (16)

      2. Beneficial Ownership Defined

         N.Y. Tax Law [section]1402(a) states that a real estate transfer tax is imposed "on each conveyance of real property or interest therein when the consideration exceeds five hundred dollars." (17) However, Tax Law [section]1405(b)(6) provides an exemption from the real property transfer tax when the conveyance "effectuate [s] a mere change of identity or form of ownership or organization where there is no change in beneficial ownership." (18) The statutory language is more akin to exclusion than exemption, but the "mere change in beneficial ownership" provision has been contradictorily interpreted by courts and the New York Department of Taxation and Finance as alternatively providing an exclusion and an exemption. (19) The bigger issue, and one that continues to plague taxpayers, is the fact that the term "beneficial ownership" is not defined in the N.Y. Tax Law. (20) This has left a feeling of uncertainty among taxpayers and a gaping hole for the courts to fill.

         In CBS Corp. v. Tax Appeals Tribunal of New York, the New York Tax Appeals Tribunal ("Tribunal") held that the RETT exemption did not apply to the May 2000 merger of CBS Corporation ("CBS") and Viacom, Inc. ("Viacom"). (21) At the time of the merger, CBS owned real estate valued at over $200 million. (22) The returns filed in conjunction with the merger claimed an exemption under Tax Law [section]1405(b)(6) aggregating 70.44 percent, consisting of a 15.56 percent exemption based upon the fact that CBS shareholders had also held Viacom stock before the merger, and a 54.88 percent exemption based on the fact that the holders of CBS voting common stock received nonvoting common stock in Viacom as a result of the merger. (23) During an Article 78 appeal of the Tribunal's holding, the court did not agree with the petitioner's interpretation of the "change-in-form" exemption "asserting that the exemption applies when a transferor retains an ongoing economic interest in the transferred real property, without regard to voting power, dominion and control." (24) The court instead agreed with the Tribunal's definition of "beneficial ownership," holding that in the context of [section]1405(b)(6), beneficial ownership could only be fully discerned by considering the phrase "in conjunction with the definitions of 'conveyance' and 'controlling interest,'" since the exemption provides that the tax shall not apply to conveyances to effectuate a mere change in beneficial ownership. (25) The court, noting that the definition of "controlling interest" refers only to voting stock, held that the surrender of 100 percent of the voting stock of CBS in return for 54.88 percent of nonvoting stock in Viacom resulted in a transfer of "controlling interest." (26) Accordingly, the court held that there had been a change in beneficial ownership rendering Viacom ineligible for a real estate tax exemption under [section]1405(b)6). (27) As a result, the real estate transfer tax was imposed on the FMV of the real estate that had a change in beneficial ownership, equal to 84.44 percent (with 15.56% being exempt [section]1405(b)(6)). (28)

      3. Acting in Concert

         A transfer or acquisition of a controlling interest in a corporation that has an interest in real property occurs when "a person, or group of persons acting in concert, transfers or acquires a total of 50 percent or more of the voting stock in such corporation." (29) "Acting in concert" describes persons who "have a relationship such that one person influences or controls the actions of another." (30) As an example of this, "if a parent corporation and a wholly-owned subsidiary each sell or purchase a 25 percent interest in an entity, the two corporations [are treated as having] acted in concert to transfer or acquire a controlling interest (i.e., 50 percent) in the entity" because the parent is deemed to be able to influence or control the actions of the subsidiary. (31)

   2. New York City Real Property Transfer Tax ("RPTT")

      1. Determination of New York City Real Property Transfer Tax

         New York City RPTT is imposed at a 2.625 percent rate (32) on direct transfers of real property, indirect transfers/acquisitions of "[50 percent] or more of the total combined voting power of all classes of stock of [a] corporation" that has an interest in New York City real property, "or [50 percent] or more of the total [FMV] of all classes of stock of such corporation." (33) It should be emphasized that unlike New York State, New York City imposes transfer tax upon the transfer of either 50 percent or more of the vote or 50 percent or more of the value of a corporation that owns New York City real property. (34) "[I]n the case of a... partnership, association, trust or other entity," the threshold is "50% or more of the capital, profits or beneficial interest in such partnership, association, trust or other entity." (35) New York City may combine multiple transfers if they are related (i.e., if they are "made pursuant to a plan" or if they are made within a three year period). (36) Similar to New York State, New York City provides for a mere change of identity or form exception. (37)

      2. Aggregation

         "A transfer of a controlling economic interest made by one or several persons, or in one or several related transfers, is subject to the [RPTT]." (38) "Related transfers, includ[ing] transfers made pursuant to a plan to... acquire a controlling economic interest in real property," "are aggregated in determining whether a controlling economic interest has been transferred." (39) Generally, all "[t]ransfers made within a three year period are presumed to be related and are aggregated unless the grantor(s) or grantee(s) can rebut this presumption by proving that the transfers are unrelated." (40)

3. THE "PROPOSED TRANSACTION" AND THE PROBLEM AT ISSUE

   This article considers how a hypothetical transaction would be treated under the current standing of the law. The Proposed Transaction is detailed in Subsection A of Part III. Subsection B then considers how Chase applies to the proposed transaction. Subsection C considers whether the court's application of the law in Chase was an appropriate application of the Step Transaction Doctrine...