|December 28, 2012|
Previously published on December 27, 2012
For many years, creative real estate lawyers and tax planners have used a sophisticated real estate transaction called an “89/11 sale” to avoid paying realty transfer tax on large real estate transfers in Pennsylvania. But a new amendment to the law closes the tax loophole, effectively ending the practice of the 89/11 sale.
Pennsylvania's realty transfer tax is imposed on almost all recorded transfers of title to real estate within the Commonwealth. Real estate businesses have long avoided the tax by structuring the transfer of real estate as a “transfer of interests.” For large real estate transactions, instead of a deed transfer, sellers would sell ownership interests in the company that owned the real estate, thus giving the buyer control of the property without recording a deed or triggering the obligation to pay transfer tax.
In the late 1980s, Pennsylvania limited the tax free nature of these transactions to those in which less than 90% of a company was sold within a three year period, giving rise to the so-called 89/11 sale in which a buyer would acquire 89% of a company holding real estate and defer acquisition of the transfer of the remaining 11% for three years, thus avoiding paying any portion of the real estate tax.
Because of their complexity, 89/11 sales were typically only used for very large real estate transactions. Because the properties involved in 89/11 transactions might otherwise have generated many millions of dollars of transfer tax revenue, politicians and government officials have long criticized the practice as an unfair loophole that deprives the state and local governments of significant revenue and gives special tax privileges to those engaged in the sales.
To close this perceived loophole, recently adopted amendments to Pennsylvania's Tax Reform Code provide that 89/11 transactions will now be fully taxable if there is a legally binding commitment to execute a transfer of the remaining 11% at a later date.
Ownership transfers of less than 90% will still be outside of the transfer tax statute. However, without a binding contract to acquire all outstanding interests, few buyers of real estate will be interested in deals that, in effect, make the seller the buyer’s long-term partner. For this practical reason, once the law takes effect in January 2013, 89/11 transactions will likely become a thing of the past.