Ohio: Proposed legislative bill would close “LLC loophole” on real estate transfer taxes

Ohio imposes a real property conveyance fee, or a transfer tax, on real estate sales.  Interested parties are circulating draft legislation that would close the so-called “LLC Loophole” on the transfer tax, which currently does not apply to the transfer of ownership interests in a pass-through entity that holds real property. The proposed bill would impose the transfer tax in these circumstances, according to the Legislative Service Commission’s (LSC) bill summary.

When real property is transferred in Ohio, the purchaser must file a conveyance fee statement. The conveyance fee statement, completed under oath, requires reporting the total price paid in the transaction, the portion that may be attributed to assets such as tangible personal property, and the amount paid for the real property, among other things. 

Currently, the real property transfer tax is imposed on the value of the real estate transferred, typically consistent with the amount paid as reported on the conveyance fee statement. The tax rate is computed as follows:

1. A statewide, mandatory tax of 1 mill ($1 per $1,000 of the value of the transferred property), which applies in every county, and
2. A permissive county tax of up to 3 mills. All except Ross County levy the permissive county tax.

The person who transfers the property must pay the transfer tax, and for almost all transfers, the tax revenue is credited to the general fund of the county where the property is located.

The LSC bill summary explains that the proposed bill would extend the tax to apply to certain kinds of transfers that currently avoid taxation, such as when real property is conveyed through the transfer of ownership of an intermediate entity that it holds title to the property. For example:

Seller A creates Realty LLC, and transfers property to Realty LLC. There is no tax because Seller A owns Realty LLC, so there is no change of ownership in the property. Then, Seller A sells its ownership stake in Realty LLC to Buyer B. There is still no tax, because it is the ownership shares in Realty LLC – not the property itself– that is being transferred. Now, Buyer B constructively owns the property, and no tax was applied to the transfer.

The proposed bill applies the transfer taxes to any transfer of an ownership interest in a pass-through entity--i.e., a limited liability company (LLC), partnership, or S corporation--that owns real estate, either directly or indirectly. For transfers such as this one, the tax would be based on (1) the percentage of ownership interest transferred and (2) the value of the property transferred.

Following on to the example above: Assume that Seller A sells 60% of its ownership stake in Realty LLC to Buyer B, and that the property owned by Realty LLC is valued at $100,000. The mandatory 1-mill state tax will equal $60 (60% of $100,000 = $60,000 * 1 mill = $60). In a county levying a 2-mill permissive tax, an additional $120 would be charged.

Additionally, the proposed legislation would also tax transfers of pass-through entities that own property indirectly, i.e., through another pass-entity: Assume that Seller A owns 100% of Realty LLC, which itself owns 50% of Building LLC. Building LLC owns property that is valued at $100,000. Seller A transfers 75% of its ownership stake in Realty LLC (and, therefore, 75% of its 50% ownership stake in Building LLC) to Buyer B. The mandatory state tax will equal $37.50 (75% * (50% of $100,000) = $37,500 * 1 mill = $37.50). A 2-mill county permissive tax would add $75.

Application of existing exemptions
Under continuing law, notes the LSC in its bill summary, there are several exemptions to the real estate transfer tax. For instance, a transfer is exempt if it involves the U.S. government, two spouses, a nonprofit agency, certain types of leases, or no consideration. The proposed bill would apply all of these existing exemptions to the expanded tax, so that the transfer of an ownership interest in a pass-through entity that owns real estate will not trigger the tax if it would otherwise be exempt as a direct conveyance.

Response to the proposal 
Some interested parties regard the current law as containing a “loophole” because the transfer of real estate and the transfer of a pass-through entity holding real estate are, in essence, the same thing.

Though some regard the current law as a loophole, that assertion is not quite as self-evident as it may seem at first blush.  A transfer of an ownership interest is not a title transfer.  The pass-through entity, even if holding real property as its primary asset, may have a going concern value, a track record of successful business practices, and a good reputation.

Arguably, the tax as applied to transfers of pass-through entities does not fall within the purposes for the tax either.  First, the county auditor does not need to be compensated for the deed transfer when there is a transfer of only a pass-through entity.

Second, the transfer of the pass-through entity may not need to be reported to reflect the true value of the real property for tax valuation purposes.  The Ohio Supreme Court has held that the transfer of a corporate entity holding real estate does not establish the true value of such real estate for property tax valuation purposes.  See, Salem Med. Arts & Development Corp. v. Bd. of Revision, 82 Ohio St. 3d 193 (1998); Gahanna-Jefferson Public Schools v. Bd. of Revision, 89 Ohio St. 3d 450 (2000).

We will be tracking the proposed bill and upcoming developments.