California Court Upholds Taxpayers’ $12 Million Assessment for San Francisco Transfer Taxes

May 24, 2022

By: Jess Johannesen, SALT Senior Manager

At a glance

  • The situation: A recent California Appellate Court opinion sheds light on how local taxes can trigger high tax assessments and create costly consequences for certain business transactions where real estate is involved.
  • Impact on your business: The case in question serves as an important reminder that real property transfer taxes, which exist at the state and local levels, can apply to the transfer of an ownership interest that directly or indirectly changes the ownership of an entity that owns real estate.
  • Next steps: Aprio’s State and Local Tax (SALT) team can help you identify and address the potential transfer tax implications of your real estate transactions, as well as recommend potential alternative structures to minimize or eliminate any transfer tax liability.

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The full story:

With 50 states and thousands of local jurisdictions, it is very difficult to monitor the potential local tax consequences of your transactions. However, local taxes can give rise to significant tax assessments, as illustrated by a recent California Appellate Court opinion. The opinion concluded that two real estate investment trusts (REITs) owed nearly $12 million in taxes, penalties and interest associated with San Francisco’s Real Property Transfer Tax (RPTT) that was triggered as a result of a merger.[1] 

Take a closer look at the case

The case revolves around a merger that occurred in May 2014. Before the merger, two entities (Entity1 and Entity2) each held title to real property located in San Francisco. Entity1 and Entity2 were owned by the same parent entity (Entity3), and Entity3 was wholly owned by another entity (Entity4). On the day of the merger, Entity4 merged with and into another entity, affecting an indirect change in ownership of Entity1 and Entity2. 

San Francisco’s RPTT is imposed on the transfer of “any lands, tenements or other realty sold.”[2] At the time of the merger, the term “realty sold” included “any acquisition or transfer of ownership interests in a legal entity that would be a change of ownership of the entity’s real property under California Revenue & Taxation Code § 64.”[3] Section 64 of the California Revenue & Taxation Code provides for the reassessment of real property for property tax purposes when there is a direct or indirect change in ownership (defined as more than 50%) of the legal entity that owns the real property.[4] 

The taxpayers (i.e., Entity1 and Entity2) argued that the merger did not involve “realty sold” within the meaning of the RPTT ordinance. They recognized that Section 1114 in the RPTT ordinance references California Revenue & Taxation Code Section 64, which applies to direct or indirect changes in ownership.  However, the taxpayers claimed that because Section 1114 includes the phrase “of the entity’s real property,” it limits the term “realty sold” and application of Section 64 only to cases where there is a direct change in ownership of the entity that owns the real property. 

In other words, the taxpayers contended that Section 1114 would have applied if Entity3 had merged out of existence, since Entity3 directly owned Entity1 and Entity2 (i.e., the entities that own the real property). However, since Entity3’s parent, Entity4, merged out of existence, that merger resulted in an indirect change in ownership that does not constitute “realty sold.” They pointed out that Section 1114 could have been drafted without the phrase “of the entity’s real property” and that would have allowed the RPTT to apply in this case.

The Court examined the language of Section 1114 and its legislative history. Specifically, the Court reviewed Proposition W, which was approved by the voters in 2016 (after the merger).[5] Proposition W increased the RPTT rate and it also amended Section 1114 to remove the phrase “the entity’s” so that it currently reads “any acquisition or transfer of ownership interests in a legal entity that would be a change of ownership of real property under California Revenue and Taxation Code Section 64.” The Court noted that the official ballot materials explained to voters that Proposition W was increasing the RPTT rate but not changing the scope of the tax. 

In addition, with respect to Section 1114, the ballot materials stated that the purpose of the amendment was “to clarify the application of the Real Property Transfer Tax to transfers of ownership interests in legal entities” and not to expand the reach of the RPTT. Thus, the Court concluded that the clarification made certain that at all times, Section 1114 applied to indirect changes in ownership, and it upheld the $12 million assessment.

The bottom line

This case serves as an important reminder that real property transfer taxes, which exist at the state and local levels, can apply to the transfer of an ownership interest that directly or indirectly changes the ownership of an entity that owns real estate.

Aprio’s SALT team has experience with these transfer taxes, and we can work with your business if it is acquiring another company that owns real estate or is engaging in an internal reorganization of legal entities that own real estate. We can identify the potential transfer tax implications so that they can be addressed as part of the transaction, as well as recommend potential alternative structures to minimize or eliminate any transfer tax liability. 

We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

This article was featured in the May 2022 SALT Newsletter.

For more information contact Jess Johannesen, SALT Senior Manager at [email protected] or call 770-353-2817 Jeff Glickman at [email protected] or call 770-353-4791.


[1] CIM Urban REIT 211 Main St. (SF) LP, et al, v. City and County of San Francisco, Cal. Ct. App., No. A161244, 03/03/2022.

[2] San Francisco Business and Tax Regulations Code §1102

[3] San Francisco Business and Tax Regulations Code §1114 (2014).  Note that in 2016, this language was modified as explained later in this article.

[4] This can be a significant tax consequence for an acquirer. California law limits the amount by which a property’s value can increase each year for property tax purposes, meaning that over time, a taxpayer’s property tax bill may reflect a value that is much lower than the property’s fair market value. However, upon a change in control, the real property can be revalued at fair market value, causing an acquirer to owe significantly more property tax relative to the prior year.

[5] A copy of Proposition W can be found by clicking here.

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.