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Philadelphia Passes Stricter Realty Transfer Tax Rules
Practical Law Legal Update w-005-1524 (Approx. 4 pages)
Philadelphia Passes Stricter Realty Transfer Tax Rules
by Practical Law Real Estate
| Published on 22 Dec 2016 • Pennsylvania |
The Philadelphia City Council recently passed a bill imposing stricter realty transfer tax rules to prevent the use of commercial real estate deal structures that avoid or minimize the payment of real estate transfer tax to the city.
On December 8, 2016, the Philadelphia City Council passed a bill that amends Chapter 19-1400 of the Philadelphia Code to close tax loopholes used in commercial real estate transactions that avoid or minimize paying transfer tax to the city.
The new Philadelphia realty transfer tax rules are scheduled to go into effect on July 1, 2017, pending Mayor Jim Kenney's signature, who is expected to sign. The new Philadelphia rules have no effect on the Pennsylvania state transfer tax rules.
Current Transfer Tax Rules
The Philadelphia realty transfer tax rate is currently 3%, but will increase on January 1, 2017 to 3.1%. Transfer tax payable to the Commonwealth of Pennsylvania is an additional 1%, making Philadelphia's combined transfer tax rate 4.1%. The aggregate transfer tax for transactions throughout most of Pennsylvania is only 2%.
Philadelphia imposes transfer tax based on the computed value of a property if there is a 90% or more change in ownership over a three-year period.
The computed value of a property is based on the assessed value of the real property multiplied by a common level ratio factor (currently 1.02). However, the computed value is often far less than the actual purchase price paid for a property or the amount paid for an ownership interest in the entity holding title to the property. Computed values can be exceedingly low in times when market prices for commercial real estate are rising quickly.
Due to the high transfer tax rate, many purchases and sales of commercial real estate are structured in a way to avoid or minimize the payment of transfer tax. One common structure used to avoid triggering the transfer tax is referred to as an 89-11 transaction, in which 89% of the ownership interest in the entity holding the real estate is transferred to the purchaser, while the seller retains an 11% ownership interest for at least three years.
New Philadelphia Transfer Tax Rules
Below are the key highlights of the new Philadelphia transfer tax rules:
- Change of Ownership. The real estate transfer tax is now triggered if there is a 75% change of ownership over a six-year period, down from a 90% change in ownership over a three-year period. This change will eliminate the use of 89-11 transactions to avoid payment of transfer tax. Potential 74-26 transactions with a six-year holding period may be an unattractive method to take advantage of tax savings.
- Acquired Real Estate Company Tax Base. When a purchaser acquires an ownership interest in an entity holding commercial real estate, the transfer tax will be imposed on the actual consideration paid for the ownership interest, instead of the typically lower computed value of the actual real estate used under the current system.
- Real Estate Definition. Long term leases of more than 30 years are now considered under the new definition of real estate to determine if a holding company is a real estate company for transfer tax purposes.
- Non-Cash Consideration. To minimize transfer tax, some commercial real estate deals are structured so that some portion of the consideration is not paid in cash, as in an exchange. The current rules allow this structure to take advantage of the artificially low computed value for realty transfer tax calculation purposes. Under the new bill, the real estate transfer tax base cannot be less than the sum of:
- any cash;
- debt assumed or taken subject to; and
- the value of property with a readily ascertainable value.
Practical Implications
Owners of commercial real estate in Philadelphia should:
- Consult with counsel to determine how these new rules, if signed into law by Mayor Kenney, will impact any pending or future transactions.
- Ensure that their properties are being accurately assessed for transfer tax purposes.
For more information on realty transfer tax in Pennsylvania, see Practice Note, Transfer Taxes: Overview (PA).