05 July 2017 California Supreme Court affirms appellate court documentary transfer tax decision in 926 North Ardmore In a wide-ranging decision that will have profound implications for investors in entities that own or lease real property located in California, the California Supreme Court (Court), by a 6 to 1 majority in 926 North Ardmore Avenue, LLC v. County of Los Angeles,1 affirmed an appellate court decision2 allowing California counties and cities to impose a documentary transfer tax on real property when a transfer of an interest in a legal entity that owns real property located in California constitutes a "change in ownership" under the state's property tax law (Cal. Rev. & Tax Code (R&TC) Section 64). The Court held "the tax may be imposed if the document reflects a sale: that is, an actual transfer of legal beneficial ownership made for consideration."3 In January of 2009, the owners of BA Realty, LLLP, which owned 926 North Ardmore Avenue, LLC (Ardmore or taxpayer) (a single member LLC (SMLLC) established to hold and manage an apartment building), sold approximately 90% of their partnership interests — 45% to each of two trusts. Ardmore reported the sale to the California State Board of Equalization (BOE) through a "statement of change of ownership" as required under California law. The BOE deemed the sale to be a change in ownership for property tax purposes under R&TC Section 64(d). In 2011, the Registrar-Recorder of Los Angeles County sent a notice demanding payment of transfer tax based on the value of the apartment building. The tax was paid, a claim for refund was denied, and litigation ensued. Under the California Documentary Transfer Tax Act (DTTA),4 counties and municipalities are authorized to impose a documentary transfer tax on transfers of real property within their respective jurisdictions.5 As the Court pointed out, the DTTA was enacted in 1967 after the repeal of the federal documentary stamp act.6 The DTTA is generally silent on the application of the tax to changes in entity control, with the exception that a taxable transfer is deemed to occur when a partnership terminates under IRC Section 708.7 Administration of the tax is delegated to California counties and cities, which must enact the tax by ordinance. While some jurisdictions have enacted specific amendments to their ordinances to incorporate the change of ownership regime under California's property tax laws set forth in R&TC Section 64, Los Angeles County (County) had not and instead relied upon the interpretation that "realty sold" in R&TC Section 11911 has the same meaning as "change in ownership" of a legal entity as used in R&TC Section 64.8 The appellate court agreed with the County's interpretation, thus allowing the County to collect a transfer tax on the change of control of a legal entity that owns real property in the County without having to enact a separate ordinance explicitly incorporating R&TC Section 64 into its transfer tax statute. On appeal, the Court ruled in favor of the County, holding that California counties and cities may impose a documentary transfer tax on real property when a transfer of an interest in a legal entity that owns real property located in California constitutes a "change in ownership" under the state's property tax law. Under the DTTA, R&TC Section 11911 authorizes a county, by ordinance, to impose a tax on " … each deed, instrument, or writings by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred or otherwise conveyed … " The taxpayer argued the DTTA is modeled after the repealed Federal Stamp Tax Act (FSTA), which the federal government never applied to this type of a scenario. The taxpayer further asserted that "realty sold" did not include conveyances of interests in legal entities with the exception of a transfer that is deemed to occur upon the termination of a partnership under IRC Section 708 as provided by R&TC Section 11925. The taxpayer contended that the exemption under R&TC Section 11925 did not apply to the transaction at issue because the realty was held indirectly by the partnership through a SMLLC. The Court reasoned that the existence of an exemption under R&TC Section 11925, as carried forward from the FSTA, for transfers of interests in partnership entities that did not terminate under IRC Section 708 shows that a transfer of interest in a legal entity could be subject to the DTTA. The Court ignored the imposition of tax on partnerships that terminate under IRC Section 708 under R&TC Section 11925(b), which arguably points to a specific need for the exemption of partnership transfers under R&TC Section 11925(a) only, as well as the history of the application of Section 708 to terminating partnerships, which results in "deemed" asset transfers (as opposed to entity transfers) for federal income tax purposes. The Court also dismissed the taxpayer's argument that no authority existed suggesting that the FSTA's real property conveyance tax ever applied to a transfer of interest in a legal entity because the FSTA had a separate provision for conveyances of corporate stock, which would have covered legal entity transfers but was not enacted by California when it enacted the DTTA. The Court did not address the application of the FSTA to an indirect transfer (i.e., the transferred entity owns interests in a subsidiary entity that directly owns real property). The Court focused on the fact that, beginning in 2009, the California Legislature mandated county recorder access to change-in-ownership statements filed with the BOE, which report changes in ownership for property tax purposes. After this mandate, the County began to routinely collect tax on transfers of interests in legal entities. Citing Thrifty Corp. v. County of Los Angeles,9 the Court adopted a similar approach to the Thrifty court, which reasoned that, "although the [DTTA] did not define 'realty sold,' the phrase used in [R&TC] Section 11911, '[ … ] is sufficiently similar to the phrase 'change in ownership' to give each phrase the same meaning."10 The Court did not address the fact that most of the local jurisdictions in California have no mechanism or practice to identify and collect tax on non-recorded transfers including forms, due dates, or administrative guidelines around the collection of penalties and interest. Further, after examining several federal cases interpreting the FSTA, the Court found the tax could be imposed: (1) only if realty was "sold"; (2) regardless of whether a document was recorded; and (3) if a transfer of beneficial ownership occurs. The Court concluded that the critical factor in determining whether the DTTA applied is whether a sale resulting in a transfer of beneficial ownership of real property occurred. Moreover, while piecing together the FSTA and federal cases, the Court further concluded that the property tax rules under R&TC Sections 64 (c) and (d), while not in the DTTA, are designed precisely to make this determination. The Court stated: "The change in ownership rules, though enacted after the [DTTA], fit squarely into this framework … The change in ownership provisions … provide rules for distinguishing 'true' changes in ownership from 'paper' ones, and they identify a subset of beneficial interest transfers that are significant enough to approximate new ownership, and thus to warrant property reappraisal."11 Under this ruling, all California counties and municipalities conceivably are authorized to impose their documentary transfer taxes (sometimes called a real estate transfer tax) upon a change in ownership of a legal entity if that legal entity owns or leases real property located in the jurisdiction, regardless of whether they have specifically incorporated R&TC Section 64 into their transfer tax ordinances. Moreover, the Court's ruling specifies no time limit on its application and consequently, it is possible that county assessors could retroactively assess their transfer taxes on transactions involving the transfer of more than 50% of a legal entity with real property located in California. Taxpayers who undertook past transactions that resulted in a change of ownership under R&TC Section 64 may need to file transfer tax returns and submit tax due as a result of the transaction. The property tax "change of ownership" rules under R&TC Section 64 are extremely complex and will need to be considered with respect to exposure on past transactions and transactions going forward. It is not known if the taxpayer will file for a motion for reconsideration or an appeal to the US Supreme Court. Considering on first blush that no federal question appears to be presented and the ruling is one of a statutory interpretation of California law, it does not appear likely that the US Supreme Court would take an appeal of the ruling. Please contact EY to discuss the potential implications of the decision to past transactions as well as any current or planned sales transactions of entities owning real property located in the state of California. 1 926 North Ardmore Avenue, LLC v. County of Los Angeles, ___ Cal.4th ___, Case No. S222329 (Cal. Sup. Ct. June 29, 2017) (Ardmore S. Ct. Opinion). 2 926 North Ardmore Avenue, LLC v. County of Los Angeles, 229 Cal. App.4th 1335 (2nd Dist. 2014) (Ardmore App. Ct. Opinion). 4 Documentary Transfer Tax Act, 1967 Cal. Stat. ch. 1332, Section 1 p. 3162 (generally codified at R&TC Sections 11901 to 11935.). 9 Thrifty Corp. v. County of Los Angeles, 210 Cal. App.3d 881, 884 (1989) (Thrifty) (holding that creation of a 20 year lease with a 10 year renewal option did not constitute a "change in ownership" under R&TC Section 61 so as to be considered "realty sold" under R&TC Section 11911). Document ID: 2017-1066 |
