Ohio legislation has been proposed to close the “LLC Loophole” on real estate transfer taxes. The bill would apply to any transfer of ownership interest in a pass-through entity that owns real estate both directly or indirectly.
“While the change wouldn’t cost a lot for many real estate owners, it is something they need to be aware of,” says Tony Constantine, CPA, tax partner at Ciuni & Panichi, Inc. “Also, if they want to call their state representative to have their voice heard about how this could affect them, now is the time to do it.
Smart Business spoke with Constantine about Ohio’s real estate transfer taxes and how the proposed bill could apply.
What does the current law state with regards to real estate transfer taxes?
The current law imposes a tax on any direct transfer of real property located within the state. The tax consists of a state and county portion, totaling $4 per $1,000 on the transaction, and it’s paid by the transferor. So, a $2.5 million sale would have a transfer tax of $10,000.
The loophole in the current law is that it only applies to direct transfers, not indirect transfers. Indirect transfers are the sale of an ownership interest or entity that owns the property. If you own a building as a single member LLC, you could sell the interest in that LCC to someone else who becomes the owner — doing that is a transfer of an interest in an entity, versus an interest in the actual property.
Why do many real estate investors prefer to purchase real estate indirectly?
There are three main reasons:
1) To shield their identity. Some prefer some privacy with respect to their real estate acquisitions and may purchase through a trust or other entity.
2) To freeze the assessed value for real estate tax purposes. Real estate sales trigger the county to revalue the property to account for any appreciation.
3) To avoid the conveyance fee. When you transfer real property, there is a transfer tax (conveyance fee) that includes a state and county tax. With an acquisition of an LLC interest there is no transfer of title, and thus no transfer tax.
Not everyone sets up their real estate transfers this way, but it happens often. It’s a nuance of the law that not everyone is aware of. It’s also an example of why real estate investors need experts who can advise them on the tax, accounting and legal situation.
Why do some want to close the loophole? Do you think the bill will pass?
They want the extra tax dollars. If you look at how the tax dollars are used, the money — even the state portion — goes to the counties and typically gets allocated to the school systems. So, school boards are big proponents because it will increase their funding. If you look statewide, it could be very beneficial for larger counties, especially since the state has scaled back on its allocations.
The bill is just a proposal, and the likelihood of it passing will become clearer only as it moves through the legislative process. There are arguments to be made on either side. The real estate community could see it as an expensive issue for those with large portfolios.
What does this mean for real estate owners and investors, in practical terms?
If it passes, it won’t stop people from selling a building. The transaction costs could get a little higher, but that’s probably a small line item in most real estate deals. Compliance costs also could go up a little. For example, if you buy a 20 percent interest in a property partnership, there will be some compliance to determine the value of that 20 percent interest.
It would also enable the county to know there was a transfer of real estate, so the assessed value wouldn’t be frozen. However, counties are already getting on top of this by checking the mortgage records.
Really, it’s just a matter of keeping an eye on the situation and making sure your voice is heard if you have an opinion. The real estate market has been steady — and this bill won’t drive that up or down. Northeast Ohio’s cap rates and prices are attractive enough that they’ll continue to draw interest, especially from people outside of the market.
Insights Accounting is brought to you by Ciuni & Panichi, Inc.