Who Pays Reet on Your Street: Washington State's Real Estate Excise Tax in Light of the 1991 Corporate Transfer Act and Beyond-how Can the Legislature Solve Deer Park Pine?

• Publication year: 1992

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 16, No. 1FALL 1992

Who Pays REET on Your Street: Washington State's Real Estate Excise Tax In Light of the 1991 Corporate Transfer Act and Beyond-How Can the Legislature Solve Deer Park Pine?

Georges H.G. Yates(fn*)

I. What Lies Ahead

The 1991 Corporate Transfer Act(fn1) represents a legislative attempt to close a court-made loophole that allows a sophisticated taxpayer to avoid Washington's Real Estate Excise Tax ("REET"(fn2)). Specifically, this loophole allows a real estate owner to (1) create a corporation, (2) transfer his real estate to that corporation as a contribution to capital, (3) sell the corporation to a second individual, who would (4) liquidate the corporation, receive title to the real estate, and avoid REET.(fn3)

Despite the Washington State Legislature's 1991 attempt to close REET's loophole, several problems and a great deal of confusion still exist. In fact, the legislature left REET in a greater state of disrepair than before. The simplest method to address this dilemma would be to completely rewrite the REET statute. The legislature's attempt in 1992, however, failed.(fn4) As a result, Washington tax planners face a REET statute that leaves several unanswered questions and provides significant tax relief to the smart practitioner's client.(fn5)

The purpose of this Comment, therefore, is twofold. First, it gives the reader a complete understanding of Washington's real estate excise tax as it exists today. Here the reader will learn what REET is and how the Washington State Supreme Court, in a series of rulings, created the currently existing corporate transfer loophole. Second, this Comment advocates replacing the current law.

Specifically, this Comment takes the position that REET is in desperate need of repair; it then considers the options available to the Washington State Legislature in 1993. This Comment concludes that, with a few important alterations, the solution lies in a proposal that died in the House Revenue Committee in 1992.(fn6)

II. An Introduction to REET

A. Welcome to REET Street

Now it is time to sit back, relax, and take a walk down REET Street.(fn7) Don't worry if at times you feel lost; you will not have been the first.

In 1951, when the planners developed REET Street, their vision was to generate revenue for education.(fn8) After a period of serene living on REET Street-no complications, no law suits, and a relatively straightforward tax statute(fn9)-the time came to remodel the street's decaying infrastructure. The tax consequences of REET were increasing as property values rose. In turn, as those consequences increased, so did the inequities among taxpayers.

The Washington State Supreme Court completed the first remodel of REET Street through a series of rulings in the 1950's and 1960's.(fn10) The court's remodel, however, left REET Street in a state of disrepair. Although the court did the best it could given the tools available, a few jogs were left in the road. The court's REET Street enabled some people to sneak by the tax collector unscathed, while their neighbors were left to pay. Several years passed before efforts were made to straighten the now crooked REET Street.(fn11)

The renovation of REET Street is back on the legislative docket. But today, there is a new generation of planners striving to transform REET Street into a viable and equitable revenue-generating community. Similar to the court's experience in the 1950's and 1960's, however, the legislature has not accomplished its goals in one fell swoop. The legislature completed minor remedial maintenance in 1991,(fn12) but new holes appeared through the efforts of tax planners who found the pavement far from impervious. Thus, REET Street remains plagued with problems.(fn13)

This story of REET Street has three purposes. First, it will place the reader back in time and afford a glimpse of how and why REET Street came to be in its current state of disrepair. From this glimpse, the reader can consider the history of REET, its underlying principles, and its practical applications. Second, it will permit the reader to view those judicial efforts responsible for REET Street's current problems. Specifically, this story explains how a few key court rulings have created a significant REET loophole affecting transfers of realty made through corporations and partnerships. Third, it will allow the reader to review the legislature's latest efforts to rebuild REET Street, and it will compare those efforts to similar legislation from other states. The reader can then consider whether REET's renovation is finished, or whether REET Street's roadbed is still in need of repair. Most likely the reader will agree with this Comment's conclusion that the legislature's efforts in 1991 only made REET worse, and that today REET Street is in need of even greater repair than before.

You, as the reader, might only be interested in certain aspects of REET. You should, therefore, feel free to go anywhere on REET Street you desire: This Comment is your road map. Should you desire to learn how REET works today, begin at Section III. If your interest lies solely in learning how REET can be manipulated through corporate and partnership realty transfers, skip to Section IV. And if you are only concerned with the legislature's recent, and potential future efforts to close the corporate transfer loophole, skip to Section VI. Enjoy your tour of REET Street.

B. What Is REET?(fn14)

Most states rely on three general types of taxes for revenue: income, property, and excise taxes. The State of Washington, however, relies on only two of these; it generates the bulk of its operating revenue without the use of an income tax,(fn15) thereby relying heavily on property and excise taxation. Generally, excise taxation refers to taxing a specific type of transaction or privilege.(fn16) In Washington, most excise taxes are measured by selling price or some other measure of income.(fn17) Although Washington's sales tax(fn18) and its use tax(fn19) are categorized as excise taxes, they apply to the'sale and use of tangible personal property; therefore, real estate sales are not covered by either tax. Instead, REET covers all statuto-rily-defined real estate sales(fn20) based on the selling price of the real estate, including the balance of any liens, mortgages, or other debts.(fn21)

For fiscal year 1990, Washington State taxes totalled nearly $7.0 billion.(fn22) During that period, REET generated $265.17 million,(fn23) or 3.8 percent of the state's total revenue, not including local taxes and state payroll taxes for workers' compensation programs. REET is clearly not the largest cash generator for Washington State coffers, yet it is considered a major state tax. It ranked sixth out of thirty-eight tax collection sources during the 1990 fiscal year.(fn24) The 1990 fiscal year was an exceptional year for REET collections, reflecting nearly a fifty percent increase(fn25) over the previous year due to a high appreciation rate in real estate values and an abnormally large number of property transactions during that period.(fn26)

C. A History Lesson

In 1951, when REET Street was originally developed, the legislature permitted any county to levy an excise tax on real estate sales, as long as this tax did not exceed one percent of the selling price.(fn27) All but one-half of one percent of the proceeds from the tax were to be placed in the county's school fund.(fn28) The remaining one-half percent was retained by the counties to cover administration costs.(fn29) The legislature recognized during the 1951 second extraordinary(fn30) session that a contingency should be added to the statute.(fn31) The contingency provided state funds when the county tax failed to generate funding equal to the existing daily school attendance credit.(fn32) The 1951 second extraordinary session also provided an expanded version of REET that incorporated taxation for the sale of standing timber and excepted several transactions from the term "sale."(fn33) But while those transactions were excepted from the definition of "sale" for REET purposes, the legislature expanded the definition of "selling price," thereby increasing the amount of potential REET revenue.(fn34)

In 1955, the legislature exempted partitions of property and transfers under both divorce decrees and property settlements.(fn35) In 1959, counties were authorized to levy REET on conditional sales or purchase options of mining property.(fn36) During the 1967 extraordinary session, the legislature provided a credit for single family residential property subsequently transferred within nine months;(fn37) that credit is currently codified as Revised Code of Washington (RCW) 82.45.105.(fn38) Then, in 1970, the legislature exempted a transfer to a corporation wholly owned by the transferor, the transferor's spouse, or the transferor's children.(fn39)

During the late 1970's, funding for basic education had become recognized as a state responsibility.(fn40) Also becoming a significant concern was the lack of uniformity in tax collection by the various counties.(fn41) By 1981, REET was shifted to the state level for administration.(fn42) Despite this shift, county treasurers still collect the tax.

In 1982, it was evident to the legislature that REET needed more bite.(fn43)...