It's been confirmed: The method regularly used by real estate companies to buy property in Pennsylvania may trigger a double transfer tax. That's the upshot of the latest bulletin from the state Department of Revenue explaining its new Realty Transfer Tax Regulations. The April 18 bulletin offers a safe harbor, but it is unworkable.

The real estate community has been up in arms over the regulations issued by the Department in December 2007. The most controversial change in the new regulations was to tax assignments of agreements of sale as if the property had actually been deeded first to the original buyer under the agreement, and then to the assignee.

This was an attempt to reverse, by regulation, the Pennsylvania Supreme Court decision in the Allebach case. In that case, the buyer "flipped" the agreement, assigning his purchase right for additional consideration, and that assignee in turn re-assigned it for yet more consideration. The Department sought to tax that extra consideration, but the Supreme Court ruled that under the Realty Transfer Tax Act, an agreement of sale is not real estate and is not taxable. In its new regulations, the Department re-characterizes each assignment as a transfer of real estate and imposes a tax on each deemed transfer.

Putting aside the question of whether the Department can, by regulation, override the Supreme Court where the buyer under an agreement of sale flips the agreement for consideration, the new regulations also would impose a double tax where an "innocent" real estate company assigns the agreement without consideration to an affiliated single purpose entity (SPE), newly formed just to own that property (as lenders increasingly require). Typically, it is the parent company, or an affiliate, that enters into the agreement of sale. When the parent company is confident that the closing will occur, it creates the SPE to take title, and assigns the agreement of sale to it. Under the new regulations, the Department would treat the transaction as if the parent actually purchased the property and then deeded it to the SPE, subjecting each transaction to tax.

When incredulous real estate professionals questioned whether the Department actually intended to tax such garden-variety transactions, the Department tried to reassure them in its December Update.¹ However, when in January it published a bulletin to explain the regulations, the Department reversed course and stated that it would apply an ad hoc facts-and-circumstances test that left taxpayers with no certainty.

After the ensuing brouhaha, the Department issued a revised bulletin on April 18 to further explain the regulations. Practitioners expecting a simple resolution are disappointed to see the Department actually retrench. New Scenario 3(a) posits a REIT that always enters into agreements in its name or in the name of its acquisition company, and then forms a wholly-owned SPE to take title before closing.  The Department's response is unyielding: "Although the parties in this scenario have a common business practice of assigning sale contracts for real estate, that fact, in and of itself, does not create enough of a distinction to result in a different legal analysis or conclusion."

Scenario 3(b) offers as a safe harbor an impractical method for accomplishing such an assignment. The initial agreement must state expressly that the nominal buyer is acting on behalf of a yet-to-be-formed SPE and "has no intent to obtain legal or equitable title." When the buyer assigns to the SPE, that assignment must result in a "repudiation" and "novation" of the nominal buyer’s duties. The financing must be in the name of the new SPE and the acquisition must be with the SPE’s funds, or funds it borrows.

It will be quite a challenge to coax sellers into agreeing to some of these provisions. Many sellers will refuse to release a buyer that assigns the agreement, especially if to a new entity with no assets, and will question the enforceability of an agreement in which the nominal buyer states expressly that it does not intend to buy.

Those who do business in other states may find this hard to believe. The Pennsylvania Realty Transfer Tax is already high.  It may take new legislation to make it clear that a buyer need not pay it twice.

Please contact Wendi Kotzen (215.864.8305 or Phil Korb (215.864.8709 with realty transfer tax questions.

1. It posed the following question and answer:

"Question #3 - Will the regulation subject an assignment of a real estate contract to tax, such as an intra-company assignment of a sale contract (i.e., a transfer of an agreement between 100 percent directly or indirectly commonly owned entities)?

Response - No. The Department has never sought to impose tax on an 'intra-company assignment of a sale contract' when one business entity in a corporate structure acts as a facilitator or intermediary for the benefit of another business entity in the corporate structure in a real estate acquisition, assigning a sale contract for no or nominal consideration. The amended regulations do not seek to impose tax on such transactions…"

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