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Real Estate Transfer Tax in Entity Acquisitions

April 10, 2014

Most people know that many states impose a tax on the transfer of real estate from one person or entity to another.  Oten this takes the form of a "stamp tax" paid at the time of recordation of the deed conveying the real estate. Less people focus on the fact that numerous states impose a transfer tax on a transfer of the ownership interests in an entity that holds real estate as its primary asset. Thus, the transfer of shares, partnership interests and membership interests are treated akin to the conveyance of the real estate itself by a deed (the "CIT Tax"). While this may seem to be logical in the case of an entity that holds real estate as its sole asset, this tax may also be imposed upon a transfer of an interest in an operating entity which counts real estate as but one of its many assets. The imposition of the CIT Tax may come as an unwelcome surprise to many engaging in a business transaction, such as a merger, acquisition, recapitalization or divestiture, that is not inherently a "real estate deal."

Among the locations within which Clark Hill has offices [1] , six impose some form of a CIT Tax. Arizona and West Virginia do not have such a tax. The various jurisdictions impose the tax quite differently and this article addresses the varying treatment within the five states and D.C. This article discusses: (1) the types of entities upon which the tax is imposed, (2) the threshold for qualifying as a change in control and triggering the tax, (3) the tax implications in the case of indirect ownership and (4) exceptions and exclusions from the tax.

Nature of Entity : While several states impose the tax on any entity that owns real estate, New Jersey [2] is the only one of the Clark Hill jurisdictions that does so. Delaware, D.C., Illinois, Michigan and Pennsylvania all impose the tax on entities that are deemed to be in the real estate business. Each of these states' transfer tax laws (1) define what characteristics cause an entity to be deemed a "real estate company" and (2) impose the CIT Tax on certain transfers of interests in such a real estate company. Two of the states impose asset based tests as follow:

  • In Illinois, there is a rebuttable presumption that an entity that owns real estate having a fair market value greater than 75% of the total fair market value of all of the entity's assets is a real estate company that is subject to the tax.
  • In Michigan, the tax is imposed only if the real estate owned by the entity comprises 90% or more of the fair market value of the assets of the entity determined in accordance with GAAP.

Pennsylvania employs a test that considers both assets and receipts. In Pennsylvania, a real estate company is an entity that derives 60% or more of its annual gross receipts from the ownership or disposition of realty or holds realty, the value of which comprises 90% or more of its entire tangible assets (exclusive of tangible assets which are freely transferable and actively traded on an established market). D.C. imposes a similar test to Pennsylvania, applying the tax only to an entity that holds real estate in the District with a value equal to at least 80% of its tangible asset holdings or derives more than 50% of its gross receipts from real estate in the District. On the other hand, Delaware imposes a more subjective four factor analysis that considers the timing of the transaction, beneficial ownership prior to and subsequent to the conveyance, the business purpose of the entity and other relevant factors.

Controlling Interest Threshold : In Illinois, New Jersey, Pennsylvania, D.C. and Michigan, there is a percentage threshold that constitutes a change in control of the entity triggering the CIT Tax. In Illinois, D.C. and New Jersey it is more than 50%. In Illinois this amount is aggregated over a two year period, in New Jersey this amount is aggregated over a six month period and in D.C. this amount is aggregated over a one year period. In Michigan the threshold is more than 80% with no time limitation. In Pennsylvania the threshold is 90% or more in a three year period. In New Jersey the threshold is more than 50% in a six month period. Delaware does not have such a percentage threshold.

Indirect Ownership : A historical method to avoid the CIT Tax in many jurisdictions was to acquire the direct or indirect parent entity of a real estate company as numerous state laws only captured the acquisition of a controlling interest in a real estate company and not its parent entity. This "loophole" has been eliminated by many states with recent legislation. In Pennsylvania, the transfer tax regulations were amended effective as of January 1, 2014 to do so. For the unsuspecting business person involved in a stock acquisition of an operating parent company that holds its real estate in a wholly owned subsidiary, as many do, the CIT Tax can be unwittingly triggered, imposing additional transaction costs. New Jersey, Pennsylvania and D.C. all capture indirect transfers in their statutes. In Delaware, Illinois and Michigan, the statutory language is murky and there is less guidance on whether an indirect transfer is subject to the CIT Tax. In these three states further examination of the specifics of the transaction should be analyzed with respect to the transfer of an indirect interest.

Exceptions and Exclusions : The various states exclude certain transactions from the CIT Tax. While these vary from state-to-state, exemptions include transactions involving publicly traded companies, tax exempt organizations, transfers between family members, and subsidized housing projects. Any proposed transaction should be carefully scrutinized to determine if an exemption may apply.

Summary : The CIT Tax may result in unexpected costs in a transaction with respect to which real estate is not the primary focus. Likewise, an entity acquisition may be structured to be CIT Tax free if structured properly. Advice should be sought in the early stages of any such transaction in order to determine if the CIT Tax may be imposed. The lawyers of Clark Hill are well versed in the CIT Tax throughout the firm's footprint and are available to advise clients on the proper planning and structuring of real estate entity acquisitions and all manner of real estate transactions.

If you have any questions about this topic, please contact Josh Farber at 412.394.7720 or . Josh is a Member in Clark Hill's Real Estate Services Practice Group, covering seven states and twelve offices.

[1] Arizona, Delaware, the District of Columbia ("D.C."), Illinois, New Jersey, Pennsylvania, Michigan and West Virginia.

[2] It is noteworthy that New Jersey is the only one of the six jurisdictions imposing the CIT Tax which has a dollar threshold before the tax is imposed.  In New Jersey, the CIT Tax is imposed only when consideration exceeds $1,000,000.

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