D.C. Recordation/Transfer Tax Triggered by Subsidiary’s Merger into Parent Company

At a glance

• The main takeaway: In D.C., the transfer of real estate via a merger of a subsidiary entity into its wholly-owned parent resulted in roughly $1 million in transfer/recordation taxes. 
• Assess the impact: The opinion by the District of Columbia Court of Appeals highlights the need for businesses to analyze all tax consequences prior to any internal reorganizations.
• Take the next step: Aprio’s State and Local Tax (SALT) team can provide your company with a complete analysis, so you can better understand the tax consequences before engaging in mergers and acquisitions. 

Schedule a free consultation today to learn more!

The full story

The D.C. Court of Appeals (D.C.’s highest court) recently held that a transfer of real property due to the merger of one limited liability company (LLC) into another triggered the District’s transfer and recordation taxes.[1] In reaching its decision, the Court concluded that the certificate of merger was the equivalent of a deed for purposes of transferring the title of the property at issue, that the transfer was not an exempt transfer of a controlling interest, and that any potential exemption from tax under the District’s Business Organization law did not apply because the transferor and the transferee were formed under Delaware law. 

A closer look at the case

The taxpayer in the case, Vornado (taxpayer), in an attempt to obtain certain federal income tax benefits under a reverse like-kind exchange, arranged for the creation of a separate LLC that purchased real property located in D.C. in 2006 with funds loaned by the taxpayer. Unfortunately, the like-kind exchange benefit did not materialize, so in 2007 the LLC was merged into the taxpayer.

At that time, no document was recorded with the District’s recorder of deeds. In 2019, when the taxpayer sold the D.C. real property to a third-party, the recorder of deeds refused to record the deed because its records reflected that the LLC was the property owner and not the taxpayer. Thus, the taxpayer was required to pay the recordation and transfer tax liabilities from the 2007 transfer that occurred due to the merger. 

The ruling explained

In affirming the Superior Court’s denial of the taxpayer’s refund claim for the taxes it paid on the 2007 merger, the Court first reasoned that the plain language of the transfer and recordation tax statutes reflect that the tax broadly applies to the conveyance of real property located in the District by a “deed or other document” that transfers “legal title” or an “economic interest” in real property.  The court also observed that the law expansively defined “deed” as “any document, instrument, or writing . . . that convey[s], vest[s], grant[s], bargain[s], sell[s], transfer[s], or assign[s] . . . any real property in the District, or any interest therein . . . .”[2] 

The Court then noted that the legislative history confirmed that the term “deed” was intended to include any document evidencing a transfer of real property, such as a certificate of merger. The Court found further support in several prior cases where it was held that the recordation and transfer tax applied to the conveyance of property by deed or by operation of law, such as when one legal entity that owns real property merges into a another.

In arguably the most notable portion of the decision, the Court rejected the taxpayer’s arguments that:

1. The merger of the LLC into the taxpayer was an exempt transfer of a controlling interest, or alternatively
2. There was no transfer at all based on the District’s Business Organization law governing mergers.

First, the Court concluded that the transfer of the real property pursuant to the merger did not qualify as an exempt transfer of a controlling interest in an entity when the ultimate ownership interest does not change because the merger resulted in the legal title in the real property being transferred from one legal entity to another and not the mere transfer of the economic interest in an entity that owns real property (i.e., a transfer of stock or LLC membership interests). 

Alternatively, the taxpayer claimed that the merger did not result in recordation and transfer taxation because the District’s Business Organization law governing mergers states that property of a merging entity vests in a surviving entity “without transfer.”[3]

The Court reasoned that it was not required to determine whether the District’s merger laws prevented the application of the recordation and transfer taxation to the transaction at issue because the merger was governed by Delaware law because the entities were formed under Delaware law. The Court fully agreed with the lower court’s rationale that a business “cannot have the luxury of choosing which jurisdiction to be incorporated in, receive the benefits of its business organization laws, and then elect to be governed by a different, more beneficial jurisdiction when taxes are to be paid.”

The bottom line

The decision in Vornado is an important reminder to businesses preparing to engage in reorganizations that are “tax-free” for income tax purposes to fully consider the potential imposition of non-income taxes. In Vornado, the taxpayer was under the impression that it was simplifying its business structure by removing an unnecessary LLCs (through the merger discussed above). Instead, the result was the need to pay roughly $1 million in taxes to complete the 2019 sale of the real estate.

In retrospect, had the taxpayer been made aware of the potential tax implication, it may have chosen to hold the property in the LLC instead of merging it out of existence. These types of unexpected taxes typically are imposed at the state and local level and need to be fully considered before transferring assets or engaging in merger and acquisition transactions. 

Aprio’s SALT team has experience with state and local taxes and how they apply to merger and acquisition transactions. We can provide a complete analysis so that you understand all the state and local tax consequences to make informed decisions, and we can recommend potential alternative structuring options to minimize those tax consequences. 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.

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[1] Vornado 3040 M Street LLC v. D.C., D.C. Ct. App. Dkt. No. 22-TX-0434, 07/25/2024.

[2] D.C. Code § 47-901(3).

[3] D.C. Code § 29-202.06(a)(3).