The Pennsylvania Department of Revenue (DOR) recently issued Information Notice - Realty Transfer Tax 2014-01 (the Information Notice) delivering some good news and bad news about how the new law that became effective January 1, 2014, affects what is a real estate company and when transfers of interests in a real estate company result in realty transfer tax being imposed.
Upon a change of 90 percent of the ownership of a real estate company in a three-year period, the real estate company owes realty transfer tax on its Pennsylvania real estate. Before January 1, 2014, a real estate company was an entity 90 percent or more of which is owned by 35 or fewer persons and that is primarily engaged in the business of holding, selling, or leasing real estate that (i) derives 60 percent or more of its annual gross receipts from the ownership or disposition of real estate, or (ii) owns real estate, the value of which comprises 90 percent or more of its tangible assets.
Act 52 of 2013 (Act 52) expanded the definition of real estate company to include not only a company that owns real estate, but also a company that owns as 90 percent or more of the fair market value of its assets, a direct or indirect interest in a real estate company.
Good News
The Information Notice helpfully provides that, with respect to companies that were not real estate companies before January 1, 2014, to test if there has been a 90 percent or more change in ownership, the three-year period starts January 1, 2014. As a result, ownership changes before January 1, 2014, do not count to determine if such companies have had a 90 percent or more change in ownership.
The Information Notice also confirms that to determine if there has been a 90 percent or more change in the ownership of a real estate company, only direct changes in that company's ownership are considered. The DOR will not look through entities to determine if there has been an aggregate indirect change of ownership.
Bad News
Act 52 also changed the realty transfer tax law to provide that, for purposes of determining if a real estate company has experienced a 90 percent or more change in ownership (and therefore owes realty transfer tax), a transfer is deemed to occur within a period of three years of another transfer or transfers if, during the three-year period, the transferring party provides the transferee a legally binding commitment or option, enforceable at a future date, to execute the transfer.
Prior to the Information Notice, it was unclear whether the DOR believed that an option or binding commitment is treated as a transfer from the date it is executed or from when it is exercised (since the option might never be exercised). The Information Notice answers this question: the DOR believes an option or binding commitment is treated as a transfer at the time the option or binding commitment is executed. Consequently, in the DOR’s view, if the owners of a real estate company sell 50 percent of the company’s interests to a buyer and simultaneously give the buyer an option to buy the other 50 percent after three years, the transaction is treated as an immediate transfer of 100 percent of the real estate company on the day the option is executed, and the real estate company would owe realty transfer tax on its real estate.
The Information Notice does explain, however, that a mere non-binding agreement to negotiate a future transfer is not a current transfer. Such a non-binding agreement to negotiate a future transfer must allow the parties to “fully negotiate” the terms of the future transfer, and the parties must be free to accept or reject any or all terms of the future transfer. Based on the Information Notice, taxpayers need to be wary of buy-sell provisions that grant an option to purchase an interest in an entity upon death, deadlock, after a set period of time, etc.
