Last month, the California Assembly passed AB 2372, a bill aimed at closing a “loophole” in California’s Proposition 13 (Cal. Const. Art. XIII). Under Prop. 13, real property is reassessed to its current fair market value whenever a “change in ownership” occurs. With regard to entities, like a corporation, partnership or limited liability company, the transfer of stock or a partnership or membership interests is not a “change in ownership” unless the any one person or entity “obtains control” of 50% or more of the voting stock or ownership interest of the company.
This rule – which focuses exclusively on control – allows clever tax planners to avoid a costly reassessment by structuring transactions to ensure that no one person or entity acquires more than 50% ownership in the acquired entity. For example, assume “X” is the sole owner of an LLC which owns an apartment complex in San Francisco. Rather than selling the apartment complex, X can sell his 100% membership interest to A, B and C. So long as neither A, B or C own more than 50% of the LLC, there is no change in ownership and no reassessment. However, if X sold his 100% membership interest to A, there would be a change in ownership because A would own more than 50% of the LLC after the transaction. AB 2372 purports to close this “loophole” by changing the law to define a “change in ownership” as the sale or transfer of 90% or more of the ownership interests in a corporation, partnership or limited liability company in a 36 month period. As can be seen, the bill does not abolish the “separate entity” treatment afforded to entities owning real property, but does clamp down on what the sponsors of the bill saw to be as one of the law’s more “obvious and egregious loopholes.” As such, there is still room for clever tax planning, such as transferring less than 90% of the ownership interests in an entity, or structuring a transfer of more than 90% of the ownership interests to occur over more than 36 months. AB 2372 also exempts the sale or transfer of stock or ownership interests in a publicly traded corporation or partnership, unless the stock or interests are acquired as a part of a merger or acquisition. The bill, co-sponsored by left-wing Assemblyman Tom Ammiano, gained rare bipartisan support in the Assembly, and even obtained the support of (or more accurately the “non-opposition” from) the influential Howard Jarvis Taxpayers Association. AB 2372 now moves to the Senate.
2 Comments
The recent case of Richman v. Hartley (2014) 224 Cal. App. 4th 1182, holds that a transfer disclosure statement (TDS) is required in the sale of mixed-use property containing four or fewer residential units, even if the transaction is primarily commercial in nature.
Under the facts of the case, in 2007, Richman entered into a contract to sell a single parcel of real estate improved with a commercial building and a residential duplex. The parties used an AIR form contract entitled “Standard Offer Agreement and Escrow Instructions for purchase of Real Estate (Non-Residential).” The AIR contract provided that “Seller shall make to Buyer, through escrow, all the applicable disclosures required by law.” Escrow was to close two years later, in 2009. Although left unsaid in the court’s opinion, the real estate and financial meltdown undoubtedly made the sale much less attractive in 2009 than it was in 2007. Hartley refused to close escrow and Richman sued Hartley for breach of contract. Hartley moved for summary judgment arguing that Richman’s failure to deliver the TDS was a violation of the purchase agreement and precluded any action by Richman to enforce the agreement. The trial court agreed and the court of appeal affirmed. The issue on appeal was whether a seller of mixed-use property is required to provide a TDS. Under §1102 of the Civil Code, the seller is required to provide a TDS to the buyer in a sale or transfer of “real property . . . improved with or consisting of not less than one nor more than four dwelling units.” The seller argued that the Transfer Disclosure Law was never intended to apply to a transaction which was essentially commercial in nature between sophisticated parties. The seller urged the court to “consider the essence of the transaction” to determine whether it was residential in nature or commercial in nature in determining whether a TDS was required. Surprisingly, the court declined to do so, holding that the statutory language was “clear and unambiguous” and “applies to any transfer of real property on which are located one to four residential units, regardless of whether the property also has a commercial use.” The court also held that the TDS requirement could not be waived and was not waived by an “as-is” clause in the AIR form contract. Undoubtedly, the decision in Richman was a windfall for the buyer. Further, it seems doubtful the Legislature intended the TDS requirement to apply to commercial transactions between sophisticated investors involving mixed-use property. However, at the very least, the Richman decision offers clear “black and white” guidance to sellers of mixed-use property. Thus, while it creates a potential trap for the unwary, the decision avoids future litigation inviting the courts to determine whether a transaction was “primarily commercial” or “primary residential” in nature. It will be interesting to see whether the Legislature responds to the decision by amending the Transfer Disclosure Law. |
blogHi. I'm Stephen Flynn. Attorney and founder of the Law Offices of Stephen M. Flynn. This is my blog. Enjoy! Archives
August 2018
Categories
All
|