New Legislation Affects Pennsylvania’s Realty Transfer Tax
More often than not, commercial real estate is owned by an entity whose sole purpose is the ownership and operation of real estate. In Pennsylvania Realty Transfer Tax (“Transfer Tax”) parlance, these entities are called Real Estate Companies, and certain transactions involving Real Estate Companies trigger Transfer Tax (even in the absence of a recorded deed or other instrument). Act 52, signed into law on July 9, 2013, in connection with the Pennsylvania General Assembly’s 2013 – 2014 budget process, effectively broadens the definition of Real Estate Company and the scope of transactions involving Real Estate Companies which are subject to Transfer Tax. The Transfer Tax provisions in Act 52 take effect January 1, 2014.
A Real Estate Company is an entity primarily engaged in the business of holding, selling, or leasing real estate that is ninety percent or more owned by thirty-five or fewer persons, and that either: (a) derives at least sixty percent of its annual gross receipts from the ownership or disposition of real estate; or (b) holds real estate, the value of which comprises at least ninety percent of its assets. A transfer of ninety percent or more of the total ownership of a Real Estate Company within a three year period will trigger Transfer Tax (as long as the transaction does not affect the continuity of the entity). Thus, a transfer of interests in a Real Estate Company (as opposed to a transfer by deed of the underlying real estate itself) could trigger Transfer Tax. This being the case, taxpayers and their advisers would often attempt to avoid classification as a Real Estate Company and/or a ninety percent shift in the ownership of a Real Estate Company within a three year period to avoid the Transfer Tax.
Act 52 effectively closes three perceived “loopholes” that were previously used to avoid the Transfer Tax.
First, under prior law, only real estate located in Pennsylvania was considered in determining whether an entity is a Real Estate Company. Act 52 requires that all real estate, wherever situated, be considered. For example, an entity owning ten parcels of real estate, each in a different state, each of equal value, and each producing the same level of income, would not have been a Real Estate Company for Pennsylvania Transfer Tax purposes before Act 52. The transfer of all ownership interests in that entity in a single transaction would not have triggered Transfer Tax. Act 52 will cause Transfer Tax to be imposed on that transaction.
Second, under prior law, an interest in a Real Estate Company was not considered equivalent to an interest in the underlying real estate. Thus, taxpayers and practitioners could transfer interests in upper-tier entities (i.e., the entity which owns the Real Estate Company that owns the actual real estate) without triggering Transfer Tax. This option is no longer viable in most cases. Under Act 52, certain entities that own Real Estate Companies will be considered Real Estate Companies, and transfers of interests in those upper-tier entities could trigger Transfer Tax.
Third, under prior law, taxpayers and practitioners could structure transactions to avoid a ninety percent change in ownership in the three-year period by use of a so-called “89-11 transaction.” A taxpayer would transfer 89% of a Real Estate Company in a given year along with an option to transfer 11% of that entity four years later at fair market value. If carefully structured, these transactions did not trigger Transfer Tax. Post-Act 52, this technique will no longer be available.
These changes are fairly significant in the Realty Transfer Tax arena as they go to the core of three techniques commonly used among taxpayers and advisers to avoid Pennsylvania Realty Transfer Tax. It is worth noting that these changes, to a large extent, bring Pennsylvania Realty Transfer Tax law in line with the prevailing Realty Transfer Tax law in Philadelphia.
The Pennsylvania Realty Transfer Tax provisions in Act 52 take effect January 1, 2014.
If you would like to discuss how these changes may affect your business, or have any other tax or estate planning questions, please contact Kevin Koscil (215.864.6827/ firstname.lastname@example.org), Bill Hussey (215.864.6257/ email@example.com), John Eagan (212.868.4835/ firstname.lastname@example.org) or Suzanne Prybella (215.864.7188/ email@example.com).
As always, the Tax and Estates Practice Group at White and Williams is committed to keeping our clients and friends up to date with important tax developments. For current information, please refer to the Tax and Estates page.
 See 72 P.S. §§ 8102-C and 8102-C.5
 72 P.S. 8101-C (“Real Estate Company”)
 See 72 P.S. §§ 8102-C and 8102-C.5
 72 P.S. § 8101-C (“Real Estate”) (prior to amendment)
 See 72 P.S. § 8101-C (“Real Estate”) (as amended)
 72 P.S. § 8101-C (“Real Estate Company”) (prior to amendment)
 See 72 P.S. §§ 8101-C (“Real Estate Company”) (as amended); 8102-C; and 8102-C.5 (as amended)
 See 72 P.S. §§ 8102-C and 8102-C.5 (as amended)
 See Phila. Code §§ 19-1402(11)(c) (real estate company determination does not depend on location of real estate); 19-1402(11)(b) (interest in real estate company constitutes interest in underlying real estate); and 19-1407(1)(b) (89-11 transactions not permitted)