A recent change in the real estate transfer tax statute coupled with more aggressive auditing/enforcement actions by the N.H. Department of Revenue Administration ("DRA") has led to unpleasant surprises for real estate investors. The change in this tax, passed by the legislature in 1996, broadened the tax to cover not only transfers of interests in real estate but also transfers of interests in "real estate holding companies."
The change was designed to address a tax avoidance technique that was then common in real estate transfer tax practice. Real estate investors, who wished to avoid the imposition of the tax, would place the real estate in an ownership vehicle such as a limited partnership, limited liability company, or corporation and transfer the ownership interests in the entity, rather than the real estate itself; because no interest in the real estate was transferred, no transfer tax was incurred. In response, the legislature enacted House Bill 2 (the budget bill for that session) in 1996, which added NH RSA 78-B:1(a)V, providing for the taxation of "transferable interests in real estate holding companies." "A real estate holding company" is defined as:
"[a] business organization, as defined in RSA 77-A:1, I, which is engaged in the business of holding, selling, or leasing real estate which:
(a)Derives more than 50 percent of its annual gross receipts from the ownership or disposition of real estate; or
(b)Holds real estate, the fair market value of which comprises more than 50 percent of the total market value of the assets of the company exclusive of goodwill.
While many practitioners were aware of the change in the statute, many, particularly those in other states, were not and because transfer of entity ownership interests did not require recording at the registry of deeds, those blissfully unaware of the change, did not learn of the change in the course of the transfer. It therefore came as something of a surprise when, starting in 2003 and early 2004 and continuing through to the present, the DRA began auditing taxpayers who had engaged in transactions in their real estate ownership vehicles. This increase in audits on the part of the DRA resulted from a couple of factors. First, the DRA, through data entry of business profits tax returns for entities engaged in the ownership of real estate and then a computer search of the returns and more sophisticated information sharing arrangements with federal tax authorities, dramatically improved its ability to identify transactions in ownership interests of real estate holding companies. The second change, in recent years, was that DRA increased its audit capabilities not only in the real estate transfer tax area but in the business profits tax area as well. As a result of these changes in DRA tax administration, real estate investors who engaged in transactions in ownership interests in their investment vehicles, who might have escaped detection under the previous regime, now became exposed to audit. Commissioner Blatsos of the DRA recently advised that he believed that substantial additional revenues have been generated as a result of more aggressive DRA audits of real estate transfer tax and other returns.
The problem was compounded because those investors who were unaware of the change in the tax, were obviously unaware of the obligation to file a "Transfer Tax Declaration of Consideration." The effect of the failure to file the declaration was to prevent the statute of limitations from running.
What's a taxpayer to do? Because the increase in audits of real estate transfer tax have not yet progressed far enough through the appeals system to have resulted in judicial interpretations of the statutory changes, the full scope of the changes is as yet undefined. There are, however, some possible ambiguities or infirmities in the statute. First, the statute does not define the term "transferable interests." While the DRA has issued a regulation which attempts to interpret the term expansively, Rev. 801.10, there appears to be a question whether ownership interests in real estate holding companies which are not freely transferable are subject to the transfer tax. Second, there is legislative authority, in connection with other pending legislation for the proposition that the legislature, at the time House Bill 2 was passed, intended to tax something less than the transfer of "controlling interests" in real estate holding companies as opposed to the transfer of any and all interests in a real estate holding company. To the knowledge of this lawyer, the DRA is currently asserting that a transfer tax is due on the transfer of any interest in a real estate holding company, even one that is not "controlling". Third, because the statute treats real estate holding companies differently than corporations that own real estate but do not satisfy the statutory definition of real estate holding companies, there is some possibility that the State and Federal constitutional guarantees of uniformity, proportionality and equal protection may provide some relief. As indicated earlier, to the knowledge of this lawyer, no appeal from the assessment of a tax under the statutory changes has yet reached decision at the Superior Court level and so these issues remain untested by the courts.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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