Pennsylvania’s Realty Transfer Tax Act and Act 52: Change Has Arrived
For years, savvy Pennsylvanians represented by knowledgeable legal counsel have enjoyed the ability of avoiding transfer tax related to transactions involving the transfer of real property. Some of the time-tested techniques used to avoid such taxation, however, are no longer available.
Act 52Act 52, which became effective January 1, 2014, limits tax avoidance options by:
Further restricting the ninety percent threshold, widely known as the "89/11 transaction";
Expanding the scope of real estate considered in determining if an entity qualifies as a Real Estate Company for tax purposes; and lastly
Making direct or indirect ownership interest in a Real Estate Company equivalent to having an interest in the underlying real estate itself.
First, Realty Transfer Tax is imposed on all transactions that result in a real transfer of a beneficial interest in real estate where consideration is present, unless otherwise excluded. The Realty Transfer Tax Act imposes liability on both parties for the full amount of tax due. Specifically, transfer tax is a tax upon the transfer of title to real estate as evidenced by a document that is to be recorded. The fact that the parties to a transaction can shift tax liability by agreement only increases the importance of examining any agreements the parties to the transfer at issue may have entered into with each other. More specific provisions of Pennsylvania's Realty Transfer Tax Act govern transfers related to business entities. For example, Pennsylvania law defines a "Real Estate Company" as a defined business model engaged in any of the following:
Holding, selling, or leasing real estate ninety per cent or more of the ownership interest in which is held by thirty-five or fewer persons and which:(i) derives sixty per cent or more of its annual gross receipts from the ownership or disposition of real estate; or
(ii) holds real estate, the value of which comprises ninety per cent or more of the value of its entire tangible asset holdings exclusive of tangible assets which are freely transferable and actively traded on an established market.
Ninety per cent or more of the ownership interest in the corporation or association is held by thirty-five or fewer persons, and the corporation or association owns, as ninety per cent or more of the fair market value of its assets, a direct or indirect interest in a real estate company.
HistoryBefore Act 52 became effective on January 1, 2014, Pennsylvania law allowed parties to enter into agreements to transfer 89% of a Real Estate Company with the remaining 11% metaphorically "held" in an option to purchase after three years, thereby circumventing the 90% threshold and avoiding Realty Transfer Tax. However, in light of such transfers, Act 52 added additional language to the statute defining when a Real Estate Company becomes an Acquired Company. The relevant Pennsylvania statute defines a Real Estate Company as an Acquired Company when there is a change in ownership which does not affect the continuity of the company and where such change in ownership has the effect of transferring 90% or more of the ownership interest within three years. This is the exact threshold that "89/11 transactions" worked to avoid. However, Act 52 imposes new language to clarify when a transfer is considered to be within three years, holding that such transfers occur when the transferring party enters a legal commitment or option to purchase the outstanding amount, the combined total of which equals or exceeds the 90% threshold.
Second, prior to Act 52, determining the existence of a Real Estate Company based on the aforementioned definition was restricted to considering real estate located in Pennsylvania. However, Act 52 broadens the scope of real estate considered when determining if an entity qualifies as a Real Estate Company by expanding the definition of real estate to include property owned in other states as well as property owned in Pennsylvania. This not only creates more tax burdens for otherwise exempt parcels of land in Pennsylvania, it creates an entirely new class of entities, possibly unsuspecting, subject to Pennsylvania's Realty Transfer Tax.
Third, a previous distinction could be drawn between owning an interest in a Real Estate Company versus an ownership interest in the underlying real estate. However, since Act 52 has gone into effect, when thirty-five or fewer individuals own 90% or more of a recognized business entity, and the recognized business entity owns a direct or indirect interest in a Real Estate Company, 90% or more of the fair market value of which make up its assets, such ownership interest now falls within the purview of the definition of a Real Estate Company.
Finally, the next question you might be thinking about is what the tax is based on and when tax is charged. Pennsylvania's Realty Transfer Tax is imposed by the Commonwealth at a rate of 1%, as well as by the sixty-seven counties, most of which also impose the same tax rate as the Commonwealth. It is also important to mention here that the Realty Transfer Tax Act has several exceptions and that, absent qualifying under one of the exceptions, "every person who makes, executes, delivers, accepts or presents for recording any document" or in whose behalf such document is presented for recording, shall be liable to pay the State tax at the rate of 1% of the value of the real estate represented by the subject document, which is payable when the document is presented for recording, within thirty days of accepting the document, or of becoming an acquired company.