New Realty Transfer Tax Regulations Change The Landscape Of Real Estate In Pennsylvania
Effective December 15, 2007, the Pennsylvania Department of Revenue (“Department”) amended its Realty Transfer Tax regulations. The Realty Transfer Tax is a tax imposed on transfers of Pennsylvania real estate based on the value of such real estate. The new regulations restrict the flexibility that buyers had in transactions that occurred prior to the effective date and impose a Realty Transfer Tax in transactions that were previously tax-free. Specifically, the new regulations present issues in transactions that involve assignments of agreements of sale, sale-leaseback transactions, like-kind exchanges and conversions of companies.
Assignment of Agreement of Sale. Historically, it was a regular practice for an entity or individual to enter into an agreement of sale for a property with the right to transfer or assign its rights as buyer to a new entity. Then prior to closing, when the due diligence period elapsed and the terms of the property financing became firm, the buyer would form a new entity whose sole purpose was to act as the owner of the property described in the agreement of sale. Once the new entity was formed, the original buyer would assign the agreement of sale to the new entity. At closing, Realty Transfer Tax would be paid for the transfer from the seller to the new entity. If there is a payment to the original buyer from the assignee in connection with the assignment, the new regulations impose a tax on the consideration paid, as well as a tax on the actual transfer of the property. In its Realty Transfer Tax Bulletin 2008-01 issued in January, 2008, and more fully discussed in the April 18, 2008 revision, the Pennsylvania Department of Revenue proposes to expand this position to impose a tax on an assignment of an agreement of sale without consideration, as well as a tax on the sale from seller to buyer.
Like-Kind Exchanges. In structuring tax-free like-kind exchanges under Section 1031 of the Internal Revenue Code, for federal income tax purposes, a deferred exchange can be accomplished by using a qualified intermediary (as that term is defined in the federal tax regulations) to hold title to real estate for a prescribed limited period of time until the exchange can be completed. The new Pennsylvania Transfer Tax Regulations would assess a tax on the transfer to the intermediary and a transfer from the intermediary, creating two transfer taxes where only one tax existed prior to the new regulations.
Conversions. In the Exton Plaza case, the Commonwealth Court held that under certain circumstances, no realty transfer tax is imposed on a conversion of a general partnership, holding title to real estate, to a limited partnership. The new regulations now restrict the holding of Exton Plaza and impose several conditions that must be satisfied to exempt the entity conversion from Realty Transfer Tax. These conditions must be strictly followed or the conversion could be a taxable event.
Lease back Transactions. Under the prior regulations, the sale of real estate with a lease back to the seller resulted in Realty Transfer Tax being imposed on the transfer of the real estate, but not on the lease back. The new regulations provide that if title to real estate is conveyed on the condition that the real estate be leased back to the grantor, the document of conveyance is taxable and the lease is taxable if it is for a term of 35 years or more, unless the conveyance and lease are executed together as part of an excluded financing transaction. To qualify as an excluded financing transaction, the seller must have the right to repurchase the real estate for a nominal amount at the end of the lease term.
In all of these situations, the Pennsylvania Department of Revenue is making significant and substantial changes to what has become in Pennsylvania reasonably standard commercial real estate procedure. Extreme care must now be taken in structuring all such transactions, and there are some planning opportunities available. To discuss those opportunities, you should contact Michael H. Krekstein, Esquire at (215) 893-8740.