“Entity transfers” are often used in commercial real estate transactions for the tax benefits they can confer on the parties to the transaction. In the typical “entity transfer” arrangement, title to real property being sold is first transferred from the current owner to a newly organized subsidiary entity, and then ownership of the subsidiary entity, rather than the title to the real property, is sold to the purchaser. The tax benefits arise from (i) the initial transfer of title to the subsidiary entity being exempt from the conveyance fee and transfer taxes and (ii) the fact that the subsequent sale of the subsidiary entity is not reported to the county auditor, which use sale transactions to adjust the value of the property on the county tax rolls to the transaction sale price. As an example, if the owner of commercial real property in Hamilton County uses an entity transfer to sell property for $16,000,000, when that property is on the County Auditor’s tax rolls as having a value of $11,500,000, the parties could save (i) $48,000 in conveyance fees and transfer taxes at closing (which total $3.00 per $1,000.00 of purchase price), and (ii) an estimated $220,000 per year in real estate taxes going forward if the property continues to be taxed at $11,500,000, rather than $16,000,000.
These types of “entity transfers” have recently been targeted by the Ohio County Auditor’s Association, which is pushing for a legislative fix to close this loophole. However, a recent decision by an Ohio appellate court may also limit the tax benefits previously available under these types of transactions.
The Eighth District Court of Appeals case of Orange City Schools Board of Education, et al. v. Cuyahoga County Board of Revision, et al. (2019-Ohio-634)(February 21, 2019) discussed an “entity transfer” in the context of a real estate revaluation complaint filed by a local board of education. The property consisted of an office complex that was on the county tax rolls as having a fair market value of $11,529,900, but the board of education complaint alleged that it had been recently sold as part of an entity transfer real estate transaction for $16,000,000, and thus the value of the property on the county tax rolls should be increased to this sale price. The board of education provided copies of the purchase agreement, appraisal, limited warranty deed and closing statement used in the transaction. While the owner of the property did not contest the information contained in any of these documents, it responded that the transaction involved the sale of personal property (membership interests in a limited liability company), and referred to several Ohio Supreme Court cases that held that the sale of a company was not the same as the sale of real property, even if the sole asset of the company sold is real property. While the Board of Revision agreed with the property owner that “the purchase agreement indicates [payment of] consideration/interest for non-realty items”, the Board of Tax Appeals reversed and held that “the purchase and sale agreement clearly indicates that the transfer of the membership interest was done solely to transfer title to the subject property” and thus “the subject property [was] sold in a recent arm’s length transaction . . . and that such sale is the best evidence of the subject property’s value . . . .”
In upholding the decision of the Board of Tax Appeals that the sale of the membership units was equivalent to the sale of the real property, the Eighth District first differentiated the Ohio Supreme Court cases cited by the property owner, as those cases (i) involved companies that had been in existence for some time and had actually used the real property in business operations, and thus included liabilities, deposits and cash accounts related to the real property, and (ii) the evidence presented in those cases showed a sale of the company, rather than the sale of real property. The Eighth District went on to note that, in the present case, the purchase and sale agreement was for the sale and purchase of real property, that the agreement outlined the entire “entity transfer” structure as the means by which the real property transfer would be completed, and that the sole purpose for the existence of the subsidiary entity was to enable the sale of real property. The Eighth District concluded that “the transfer of the membership interest described in the sale and purchase agreement was done solely for the purpose of transferring title to the property”, and that, as a result “this was a sale of real property and not a membership transfer”, and therefore “the BTA’s conclusion that the property was sold in a recent arm’s length transaction in February 2015 for $16,000,000 was lawful and reasonable.”
This decision by the Eighth District may give boards of education (which receive much of their income from real estate taxes) a new means for attacking and piercing these entity transfer real estate transactions. While this type of revaluation action on the part of boards of education will require more factual and documentary evidence than a standard revaluation situation, and may be more costly to pursue, since entity transfers are typically used in high-dollar commercial real estate transactions, aggressive boards of education may find that the resulting tax income is worth the effort.
Andrew J. Hogan
Partner, Kohnen & Patton LLP