Ohio Supreme Court Confirms Decision of Eighth Circuit Regarding “Entity Transfers” of Real Property
In a previous article, I discussed 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), that involved an “entity transfer” of real estate, in which 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. Structuring the real estate transfer in this manner can have tax/financial benefits for both the seller and the purchaser, but as a result, such arrangements have increasingly been attacked by both County Auditor offices and school boards.
County Auditors are tasked with the job of determining the true value of real property for real estate tax purposes, and, generally speaking, the best evidence of this true value is a recent, arm’s length sale of the property in question. In the Orange City case, the Board of Education (“BoE”) got wind of a possible sale of the property via a new, large mortgage imposed against the property at the same time that title to the property was transferred via a supposedly exempt transaction. The BoE extrapolated a sale price based on the mortgage amount and typical “loan to value ratios”, filed a valuation complaint, and then, via discovery, was able to obtain copies of various transaction documents, including the purchase contract, a lender appraisal and the closing statement, all of which evidenced an “entity transfer” of the property for $16,000,000 (approximately $4,500,000 more than the current value of the property on the Auditor’s tax rolls). Although the Board of Revision sided with the owner of the property, the Board of Tax Appeals found that the purpose of the entity transfer was to achieve a sale of the property, and that the $16,000,000 paid in that transaction was indicative of the actual value of the real estate. The Eighth Circuit agreed, concluding 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”, that “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 was affirmed by the Ohio Supreme Court (160 Ohio St.3d 21) based on its decision under a similar fact pattern in the case of Columbus City Schools Board of Education v. Franklin County Board of Revision (159 Ohio St.3d 283). That case involved a recently constructed apartment complex that was valued by the Auditor for tax year 2015 at $16,000,000. However, the CCSBoE found (i) a December, 2014 mortgage for $23,536,000, along with (ii) an October 6, 2015 exempt transfer of the property and assumption of the mortgage, and concluded that the property had been the subject of a recent sale for approximately $34,000,000, and filed a complaint to have the value of the property increased accordingly. Through the discovery process, the CCSBoE obtained (a) a June 22, 2015 purchase and sale agreement that specifically provided for a “drop down LLC sale” transaction, (b) a lender appraisal valuing the property at $36,500,000 (a portion of which was for personal property), and (c) a closing statement dated October 6, 2015 (the same date as the exempt transfer and mortgage assumption) signed by the seller and buyer listed in the purchase and sale agreement and listing a sale price of $35,250,000, all of which were submitted as evidence of the sale transaction. Based on the foregoing, the Board of Tax Appeals held that the CCSBoE “has met its initial burden to show that there was a qualifying sale of the subject real property”, rejected the owner’s subsequent appraisal of $25,000,000, and valued the real property at $34,458,000 (the sale price less the stated value of the personal property included in the transaction).
In affirming the Board of Tax Appeals’ decision, the Ohio Supreme Court overruled several significant arguments typically raised by those claiming that an entity transfer is not a sale of real property:
- The sale documentation is inadmissible. Although the owner of the property tried to have the sale transactions documents excluded as hearsay and having not been properly authenticated according to the Rules of Evidence, the Supreme Court found “because the BTA is an administrative agency rather than a court, the Rules of Evidence are not binding on the BTA, though they may be used for guidance . . .” and “the BTA did not err in considering the settlement statement because as an administrative tribunal, it is permitted to rely on hearsay as a general matter.” In addition, the Supreme Court noted that the documentation was provided by the owner of the property as part of the discovery process, and the owner never disputed the information that was contained in it. As a result, the Supreme Court concluded that the BTA could reasonably consider such information, and that it would “defer to the BTA’s determination of the competency as well as to its determination of the credibility of the evidence presented to it” in finding that the CCSBoE has met its obligation of showing the existence of a qualifying sale transaction and shifting the burden to the property owner to disprove or limit the same (which, according to the BTA, it did not).
- It was a sale of company ownership (i.e., personal property). It differentiated prior Supreme Court decisions in which the contracts (i) were exclusively for the purchase of entity ownership, and made no mention of the sale or value of separate company assets, or (ii) were not arm’s length or did not involve open-market negotiations (being one owner buying out the interests of another, or involving leaseback scenarios). On the other hand, the Supreme Court recognized that the present case involved what was clearly a real estate purchase contract that expressly identified the real property in question, and specifically included the alternative means of closing the transaction.
- The transaction involves the sale of a business operation, because property is income producing, or the transaction includes other assets. While the Supreme Court agreed that an “entity’s going concern value is distinct from the value of its real-estate assets”, (i) the fact that this is income (i.e., rent) producing property is irrelevant, because that “is integral to the value of the real estate . . . [and] no other income is derived from the use of the property that would relate to any business value other than the value of the real estate itself”; and (ii) the fact that the sale may include other assets in addition to the real estate simply “places this case in the category of those sales of income-producing properties in which the total contract price constitutes a presumptive starting point for the value of the real estate subject to reduction if the owner demonstrates the propriety of allocating some of the contract price to assets other than the real property”.
- There is no official sale or sale price. The non-existence of a conveyance fee statement (or the existence of only an exemption statement) is not definitive in determining whether a sale has taken place – “a purchase contract may constitute both evidence of the sale and of the amount of consideration paid for the real estate” and “the evidence included a deed and settlement statement that are related to that purchase agreement”, so that “the absence of an officially reported sale price on a conveyance-fee statement is immaterial on this record.”
While Columbus City Schools Board of Education v. Franklin County Board of Revision may not sound the death knell for structuring Ohio real estate transactions as entity transfers (it does not address the validity of the exempt transfer and the non-payment of the real estate conveyance fee, and using this type of structure can make it more difficult for local boards of education to identify real estate sales transactions and pursue valuation changes), it certainly does open the door for boards of education to pierce through the entity transfer structure and obtain real estate value (and tax) increases in transactions that were previously unavailable.
Andrew J. Hogan
Partner, Kohnen & Patton LLP