Potential Tax Trap: Real Estate Transfer Taxes and Entity Acquisitions

State and local real estate transfer taxes can be a significant and sometimes overlooked cost in certain acquisition transactions. In many states, including Illinois, the transfer of a controlling interest in an entity that owns real estate can trigger a real estate transfer tax, even though the real estate itself is not transferred. Currently, 16 states impose some sort of a real estate transfer tax upon the transfer of a controlling interest in an entity that owns real estate located in that state.

The transfer of a controlling interest for real estate transfer tax purposes typically means a transfer of “control,” which can be as little as 50 percent and as high as 90 percent, depending on the real estate transfer tax laws of the relevant state. Many states aggregate certain transfers of interests occurring within a particular time frame in determining whether there is a transfer of “control.” Illinois, for example, aggregates certain transfers that occur over a two-year period. Additionally, many states require that the entity be a “real estate entity” in order to impose a real estate transfer tax upon a transfer of control. A “real estate entity” generally means an entity engaged in a real estate business where a certain minimum percentage of its income and assets are derived from or consist of real estate.

Certain real estate transfers (including certain transfers of a controlling interest in a real estate owning entity) are exempt from real estate transfer taxes. Although the laws vary from state to state, exempt transfers typically include: (i) an exchange of interests in an entity in order to effectuate a mere change of identity or form of ownership or organization where there is no actual change in beneficial ownership, (ii) transfers involving a parent and subsidiary, (iii) mergers between corporations and (iv) transfers of interests in publicly traded companies. The types of exemptions and the legal conditions for claiming exemptions differ greatly from state to state and require an analysis of the relevant state’s real estate transfer tax laws in order to properly ascertain whether a real estate transfer tax may be due.

As more and more states look to increase revenues, the trend will be for more states to expand the application of real estate transfer taxes to transfers of controlling interests in real estate owning entities. Accordingly, more and more acquisition transactions involving the transfer of a controlling interest in an entity are likely to trigger real estate transfer taxes. Clients engaged in an acquisition transaction should be made aware of the potential costs resulting from an imposition of real estate transfer taxes and should take these costs into consideration when evaluating the overall cost of the acquisition and in allocating these costs  among the parties to the acquisition.

FEDERAL TAX NOTICE: Treasury Regulations require us to inform you that any federal tax advice contained herein is not intended or written to be used, and cannot be used, by any person or entity for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code