Notwithstanding its name, Pennsylvania realty transfer tax extends beyond the mere taxation of transfers of real estate. The tax also applies to certain transfers of ownership interests in a so-called “real estate company.” Generally, a “change” of 90% of the total “capital and profits ownership interest” in such a real estate company during a three-year period will be a taxable event.
A “real estate company” for purpose of the tax is a corporation or association (which includes among other things a general or limited partnership and a limited liability company) that (i) is owned by 35 or fewer persons, (ii) derives 60% or more of its annual gross receipts from the ownership or disposition of real estate; and (iii) holds real estate that is 90% or more of its tangible assets.
As set forth above the tax applies to a “change” of 90% of the ownership interest in a three-year period. A “change” can be effected by a sale, exchange, gift, bequest or other transfer of the ownership interest. The tax on an ownership change is reported on a “declaration of acquisition” that must be filed within 30 days of the date of the change. If the change is effected by a series of transfers, the declaration is required after the transfer that completes the change, in other words the transfer that reaches or breaches the 90% threshold. The tax at the state level is 1% of the computed value of the property or properties owned by the company. The computed value is equal to the property or properties’ assessment multiplied by the applicable county common level ratio factor.
Are there “changes” that are excluded from the tax? Yes, however, it is important to note that for the most part the long list of non-taxable transfers that apply to transfers of real property itself does not apply to transfers of real estate company interests.
The primary exclusion from tax for transfers of a real estate company is a transfer of an ownership interest between members of the same family. “Members of the same family” are defined by statute as “(a)ny individual, such individual’s brothers and sisters the brothers and sisters of such individual’s parents and grandparents, the ancestors and lineal descendents (sic) of any of the foregoing, a spouse of any of the foregoing, and the estate of any of the foregoing. Individuals related by the half blood or legal adoption shall be treated as if they were related by the whole blood.”
Importantly, for estate planning and estate administration this intra-family exclusion means that a transfer of a real estate company interest from an estate to a family member is exempt. However, there is no corresponding exclusion for a transfer of a real estate company interest into a trust, even if the trust is for the benefit of family members. This is significant for estate planners and is one way in which the transfer of real property is treated differently from the transfer of a real estate company interest under this particular tax. This is a frustrating and perhaps unintentional result, but it is the result under the applicable regulations.
It should also be mentioned that the list of intra-family transfers that are not taxed when real property itself is being transferred is different from the list of intra-family transfers that are not taxed when a real estate company’s interests are being transferred. Again, this is puzzling, but it is the law.
Finally, although not strictly speaking a “real estate company”, certain agricultural businesses known as “family farm businesses” can also become an “acquired company” triggering a transfer tax upon transfers of an equity interest. Although this becomes complicated, generally speaking, transfers will not count as a taxable transaction provided that 75% of the book value of the corporation or partnership is still devoted to agriculture after the change and 75% of any class of stock (for a corporation) or the profits or surplus (for a partnership) are owned by “members of the same family” (as defined above).
This article presents a general description of how transfer taxes can apply to transfers of interest in a corporation, partnership or limited liability company. There are some subtleties and some planning opportunities. Consultation with a lawyer familiar with these matters should be on your to do list if you are contemplating any such sale or transfer.
— Rod Fluck