The Florida legislature has closed the door on a popular exemption from documentary stamp taxes on the transfer of real estate.
Since 2005, real estate investors have taken advantage of a Florida Supreme Court ruling Crescent Miami Center, LLC v. Florida Department of Revenue, which says there is no “consideration” for documentary stamp tax purposes if unencumbered property is transferred to an entity whose ownership is the same as the owners before the transfer.
“This exemption allowed properties to be transferred to unrelated third parties free of documentary stamp taxes,” says Ellen Rose, a partner at Katz Barron Squitero Faust.
The Florida Legislature took notice and recently enacted a change in the documentary stamp tax law that largely eliminates this strategy after July 1, 2009.
Smart Business spoke with Rose about the new law and how it could affect you.
How did the Crescent exemption work?
First, it requires real property held free and clear of mortgages or other liens. The property owners would then form a new artificial entity, such as a corporation or LLC, and issue the equity interests to the same individuals who were the existing property owners, in the same proportions.
Next, the property owners would transfer the property to the new entity. Then, the equity interests in the new entity are transferred to third parties, who then own the real property indirectly through the new entity. In order to accommodate more complex ownership structures, additional steps that followed the same principles of the exemption were often added to the process. Since many institutional and wealthy private investors acquire and hold real estate without financing, this exemption strategy was useful in countless transactions across the state. Documentary stamp taxes on a $10,000,000 transaction are $70,000 ($105,000 in Miami-Dade County, including the local surtax).
How did the new legislation change this?
Stated in its simplest terms, if a transfer is made to a ‘conduit entity’ for less than ‘full consideration,’ the new Act imposes documentary stamp taxes if the ownership interests in the conduit entity are transferred for consideration within three years of the first transfer. The devil is in the details. The Act is loaded with definitions, technical details and opportunities for unintended consequences.
It is not necessary that all of the stock or membership interests in the conduit entity be transferred. Minority positions will trigger the tax, as will indirect ownership transfers, such as where the sole shareholder of the conduit entity is itself an artificial entity and the stock in that upstream entity is transferred. This introduces a more complicated and expensive valuation process, because the ownership interests in the entity are being valued, not the underlying real estate. In addition, if the conduit entity also owns other assets, the documentary stamp taxes are prorated based on the value of the real estate transferred to the conduit for less than full consideration, relative to the value of all assets (not just real estate) owned by the entity.
The definitions in the Act introduce more complexity. A ‘conduit entity’ is defined to mean a legal entity to which the real estate is transferred by the real estate owner who also owns a ‘direct or indirect’ interest in the entity ‘or a successor entity.’ This is designed to capture ownership structures that include any number of parent entities, and is intended to survive mergers of the original conduit entity. An organizational chart will now have to be watched very carefully for the three-year period beginning with the date the conduit acquired title to the real estate.
The definition of ‘full consideration’ seems to capture subsequent transfers at the conduit entity level even if documentary stamp taxes were paid on the original real estate transfer, if the taxes were not paid on the full consideration. Full consideration is defined by the Act as ‘the consideration that would be paid in an arm’s length transaction between unrelated third parties.’
The Act also includes a statement of legislative intent that introduces the likelihood that related transactions would be collapsed together to determine whether a taxable transaction has occurred. Prior to this Act, the documentary stamp tax law followed a form over substance approach. The determination of whether and to what extent a transfer was taxable depended on the structure of that transfer standing alone and, to a large extent, on the contents of the documentation for the transfer. Related transactions were not evaluated together to determine taxable effects. The legislative intent states that the Act is to be ‘construed liberally in having the purpose of imposing the documentary stamp tax on the transfer for consideration of a beneficial interest in real property.’
Are there exemptions?
Absolutely. Transfers to conduit entities made before July 1, 2009, are exempt no matter when the subsequent equity interests are transferred. Publicly traded interests are exempt. Gifts of ownership interests in the conduit entity are exempt if there is no consideration paid in connection with the gift. This raises the question of whether the gift is exempt if debt is assumed as part of the gift or if the gift is related to a purchase of additional stock. In addition to gifts, estate-planning transfers are exempt, but only if they consist of a transfer from a natural person to an irrevocable grantor trust. Finally, the Crescent case still apparently controls if the time elapsed between the transfer to a conduit entity and the transfer of interests in the conduit entity is more than three years.
Transfers from property owners to their wholly owned entities are still exempt and that has not been disturbed by the Act. Going forward, real estate investors and their counsel will need to keep a watchful eye on mergers, acquisitions and straight transfers of equity interests in companies who own real estate directly or through subsidiaries to avoid inadvertent tax consequences.