Washington Reminds Taxpayers that Transferring Equity Interests Can Result in Real Estate Transfer Tax
Some states apply real estate transfer tax to the sale of a controlling equity interest in an entity that owns real estate, as a recent Washington Tax Determination highlights.
By Jeff Glickman, SALT partner
States impose dozens of taxes, but in our practice or in our business, we mostly deal with the mainstream taxes such as income/franchise, sales/use, property and business license taxes. However, one tax that is imposed by many states and that can apply when least expected is real estate transfer tax. As its name suggests, this tax is typically imposed upon the transfer of an interest in real estate.  However, of the states that impose a real estate transfer tax, some also apply the tax to the sale of a controlling interest of equity in an entity that owns real estate located in the state. These are commonly referred to as “controlling interest” taxes, and as a recent Washington Tax Determination highlights, these taxes can arise as a result of a simple sale of an LLC interest. 
In this case, a member (“seller”) of an LLC that owned real estate in Washington sold its entire 52.5 percent interest in the LLC to another party. The seller did not file a Washington Real Estate Excise Tax (“REET”) return and did not pay any REET. When the LLC filed its renewal and annual report with the Washington Secretary of State, the report revealed that there had been a transfer of a controlling interest and that the LLC owned real estate in Washington. A letter was sent to the LLC inquiring about REET, and when no response was provided, an assessment was issued against the LLC.
Washington imposes a REET upon the sale of real property located in the state.  “Real property” is defined to include “the ownership interest or beneficial interest in any entity which itself owns land or anything affixed to the land.”  The term “sale” includes “the transfer or acquisition within any twelve-month period of a controlling interest in any entity with an interest in real property located in this state for a valuable consideration.”  A “controlling interest” is “fifty percent or more of the capital, profits, or beneficial interest in such partnership, association, trust, or other entity.”  The REET is typically an obligation of the seller, but in the case of the transfer of a controlling interest, the state may also enforce the obligation against the entity that owns the real property or any party that acquired the interest. 
The LLC did not dispute that a controlling interest transfer occurred. The ruling discusses a couple of possible exemptions and quickly determines that they do not apply. First, the state exempts transfers that “consist of a mere change in identity or form of ownership of an entity where there is no change in the beneficial ownership.”  This might apply, for example, to the transfer of real property from one corporation to another when both corporations have identical ownership. Clearly, however, under the facts of this determination, that exemption does not apply since the seller before the transfer owned 52.5 percent of the LLC and now owns zero percent.
Second, the state exempts certain transfers for which no gain or loss is recognized for federal income tax purposes for entity formation, liquidation or dissolution, and reorganization.  This exemption would apply, for example, when an entity contributes real property to a newly-formed, wholly-owned subsidiary since any gain from that contribution would not be recognized under section 351 of the Internal Revenue Code. Again, in this case, no such non-recognition provision applies.
Taxpayers must be aware of all of the potential taxes that can impact their transactions. When a taxpayer owns real estate or owns an entity (directly or indirectly) that owns real estate, particular attention must be paid to internal corporate restructurings, mergers and acquisitions, and other transactions that may transfer the real estate or any direct or indirect interest in the entity that owns real estate. Aprio’s SALT team has significant experience dealing with REETs and can assist you in determining the tax consequences of your transactions, as well as make recommendations for alternative structures that may minimize these taxes. We will continue to monitor these and other SALT developments, and we will include any significant updates in future issues of the Aprio SALT Newsletter.
 One of the reasons that there is not much compliance surrounding this tax for buyers and sellers is due to the fact that when real estate is sold, the closing attorney or title agent has already added the applicable tax to the closing statement, and it gets paid when the deed is recorded. For example, you may not have even realized that you paid real estate transfer tax when you sold your home!
 Washington Tax Determination No. 15-0329, 35 WTD 355 (July 29, 2016). In these situations, since there is no actual transfer of real estate (i.e., no deed is recorded because the legal owner of the real estate, the LLC, does not change), compliance for the tax typically falls on the parties to the transaction.
 RCW 82.45.060.
 RCW 82.45.032(1).
 RCW 82.45.010(2).
 RCW 82.45.033(1)(b).
 RCW 82.45.080(1); RCW 82.45.033(2)(b).
 RCW 82.45.010(3)(p).
 RCW 82.45.010(3)(q)(i). This includes, but is not limited to, non-recognition of gain or loss because of the application of section 332, 337, 351, 368(a)(1), 721 or 731.
This article was featured in the October 2016 SALT Newsletter. To view the newsletter, click here.
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.