Feds to the Rescue: 2019 California Transfer Tax Update

• Publication year: 2019
• Author: Dena M. Cruz

Feds To The Rescue: 2019 California Transfer Tax Update

Dena M. Cruz

Dena M. Cruz is a partner at Berding Weil, LLP in Walnut Creek, CA and is a former member of the Executive Committee of the Real Property Section of the State Bar of California.

I. INTRODUCTION

California Assessor-Recorders require the payment of a tax on most instruments that transfer an interest in real property.¹ The documentary transfer tax is not a fee paid in connection with the recordation of deeds or other documents evidencing transfers of ownership of real property. Rather, it is an excise tax on the privilege of conveying real property by means of a written instrument.² Such taxes typically become due on execution and delivery of the document transferring title. Federal, state, and local laws must be reviewed before execution and delivery of the transfer document to determine whether the transfer is subject to taxation, if an exemption is available, or when the payment becomes delinquent.

An introduction to California's transfer tax laws first appeared in 2005 in the California Real Property Journal.³ An update, which addressed indirect entity transfers and exemptions from transfer tax in greater depth, appeared in Spring 2015, entitled 2015 Update: Transfer Taxes in California.⁴

This article has three aims. These are:

• Discuss the 2017 California Supreme Court decision on legal entity transfers found in 926 North Ardmore Avenue, LLC v. County of Los Angeles, 3 Cal. 5th 319 (2017) ("Ardmore"). This case, although mentioned in the 2015 update, had not been finally decided at the time the update was published.
• Discuss the repeal of the technical termination rules in the "Tax Cuts and Jobs Act,"⁵ and its impact on the Continuing Partnership Exemption contained in California Revenue & Taxation Code section 11925.⁶
• Provide an abbreviated update on all charter county and city transfer tax ordinances. A complete listing of all charter city and county transfer tax ordinances is available to members of the Real Property Section of the California Lawyers Association ("CLA") on the CLA's website at https://calawyers.org/transfer-tax-table.

II. CALIFORNIA TRANSFER TAX

In 1967, the California Legislature enacted the Documentary Transfer Tax Act⁷ ("DTTA") to replace the Federal Stamp Tax Act on Conveyances ("Federal Stamp Act").⁸ The Federal Stamp Act was repealed in 1965.⁹ The California Legislature modeled the DTTA after former section 4361 of the Federal Stamp Act, and the DTTA applies to conveyances of stock and realty.¹⁰ The Legislature did not, however, incorporate the Federal Stamp Act's language on transfers of stocks and bonds from subchapter B of chapter 34 of the Federal Stamp Act. The repeal of the stamp tax on transfers of capital stock became effective January 1, 1966; the repeal of the stamp tax on the sale of realty became effective January 1, 1968.¹¹

The DTTA does not expressly require that it be construed in the same manner as the Federal Stamp Act, but the DTTA employs language nearly identical to that found in the former federal statute. Courts infer from this fact that the California Legislature intended to perpetuate the federal administrative interpretations of the DTTA.¹² In fact, numerous counties and cities, including but not limited to, San Francisco,¹³Alameda,¹⁴ Contra Costa, ¹⁵ San Diego,¹⁶ and Ventura¹⁷ state in their transfer tax acts:

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In the administration of this ordinance the recorder shall interpret its provisions consistently with those Documentary Stamp Tax Regulations adopted by the Internal Revenue Service of the United States Treasury Department which relate to the Tax on Conveyances and are identified as Sections 47.4361-1, 47.4361-2 and 47.4362-1 of Part 47 of Title 26 of the Code of Federal Regulations, as the same existed on November 8, 1967, except that for the purposes of this ordinance, the determination of what constitutes "realty" shall be determined by the definition or scope of that term under state law.

Some counties, especially in Northern California, have transfer tax ordinances that distinctly differ from the DTTA. Others simply incorporate by reference some or all of the exemptions contained in the DTTA. What qualifies as "realty sold" and available tax exemptions can only be determined by a thorough review of the transfer tax provisions in the jurisdiction where the property is located. Exemptions available in county ordinances are not necessarily available under city code sections, and vice versa.¹⁸

III. WHAT IS A CHANGE IN OWNERSHIP FOR TRANSFER TAX PURPOSES AFTER ARDMORE?

In one of the most important transfer tax cases occurring since the landmark decision, Thrifty Corp. v. County of Los Angeles ("Thrifty"),¹⁹ the California Supreme Court in Ardmore held that a transfer tax can be imposed when there is a conveyance of the beneficial ownership in real property, directly or indirectly. Thus, unless an exemption applies, transfer tax must be paid when an interest in a legal entity is conveyed and the legal entity owns real property in California. The Court's decision turned on the definition of "realty sold" as used in California Revenue & Taxation Code section 11911.

A. Ardmore Factual Background

In 1972, Mr. and Mrs. Averbook established a family trust that owned several assets, including an apartment building at 926 North Ardmore Avenue, Los Angeles, California. When Mr. Averbrook passed away in 2007, the property transferred into an administrative trust for Mrs. Averbook's benefit. The couple's two sons were the named trustees of the administrative trust.

The sons, the new trustees, first formed two entities: 926 North Ardmore Avenue, LLC ("Ardmore LLC") and BA Realty LLP ("BA Realty"). The administrative trust was the sole member of Ardmore LLC and that trust held a 99% limited partnership interest in BA Realty. Then events grew complex.

• In August 2008, the administrative trust conveyed the apartment building to Ardmore LLC.
• The administrative trust then transferred its membership interest in Ardmore LLC to BA Realty.
• In December 2008, the family trust distributed its limited partnership interest in BA Realty to four subtrusts: 65% to the Survivor's Trust; 10% to the Bypass Trust; 1% to the Exempt Marital Trust; and 24% to the Non-Exempt Marital Trust. All of the subtrusts were established for Mrs. Averbook's benefit.
• In January 2009, Mrs. Averbook directed several of the subtrusts to sell approximately 90% of the partnership interests in BA Realty to two irrevocable trusts she created for her sons, Allen's Trust and Bruce's Trust.
• The sales agreements between the Survivor's Trust and the marital trusts, on the one hand, and the sons' trusts, on the other, required the trustees of the sons' trusts to issue promissory notes to the transferors in an amount ascertained by an appraisal firm. The sales were memorialized with master transfer agreements, promissory notes, security agreements, and partial guarantees.²⁰ The transactions did not involve the execution of a deed or other instrument transferring title. The agreements did not mention the building or its location, nor were the agreements recorded.²¹ Following this transaction, Allen's Trust and Bruce's Trust each held a 44.6% interest in BA Realty; the Bypass Trust held a 9.8% interest in BA Realty; and BA Realty Management LLC continued to hold the remaining 1% general partnership interest in BA Realty.²²

The trusts reported the sale of the interests in BA Realty to the California State Board of Equalization ("BOE") on BOE Form 100-B.²³ The transaction was not described as constituting a change in ownership for transfer tax purposes. The BOE later reported the transfer to the Los Angeles County Assessor, who then reassessed the property.²⁴ Because more than 50 percent of the interests in the apartment building were cumulatively transferred to the sons' trusts, the county held that a change of ownership had occurred under section 64(d). The county then reassessed 926 North Ardmore Avenue for property tax purposes.

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In 2009, the California Legislature amended California Revenue & Taxation Code section 408 to provide the county recorders access to assessor records to determine whether to impose a documentary transfer tax.²⁵ The Legislature later added section 408.4 to allow a city tax administrator access to the assessor records.²⁶

In August 2011, more than two years after the subtrusts' transfer of interests to Allen's Trust and Bruce's Trust, the Los Angeles County Registrar-Recorder sent a "Notice and Demand for Immediate Payment of Documentary Transfer Tax" to the property-owning entity. The county's notice cited both section 11911 and Los Angeles County Code section 4.60.020. It asserted that $2,160.40 in documentary transfer tax was owed to the county and $8,838.00 was owed to the City of Los Angeles based on the value of the property as of the date of the transfer. Ardmore LLC, as plaintiff, paid the taxes under protest, claiming that no tax was due and payable on the basis of "a Transfer of Realty Held by a Continuing Partnership (RTC § 11925; LA CC § 4.60.080),"²⁷ and then promptly filed refund claims.

Ardmore LLC based its claim for a tax refund on several theories. First, it contended that no taxes were due because transfer tax is a tax on the sale of real property and not a tax on the sale of interests in entities, except for sales of interests in partnerships holding real property that result in the termination of the partnerships under IRC § 708. Second, it claimed, in the alternative, that the sale of membership interests in BA Realty did not qualify as a termination of the partnership under section 708, and that no reassessable event had occurred to trigger the DTTA. No tax was due because (1) BA Realty, the entity transferred, did not hold legal title to the apartment building; (2) [Ardmore] LLC, which held title to the property, was not transferred; and (3) legal title to the property did not change. Stated another way...