San Francisco Voters Approve Changes to Real Property Transfer Tax Rates
On November 11, 2008, San Francisco (the "City") voters approved Proposition N, approving an ordinance that amends the San Francisco Business and Tax Regulations Code ("Code") by: (1) increasing the real property transfer tax rate from 0.75% to 1.5% if the consideration for or value of the transfer is $5 million or more; (2) reducing the tax on transfers of residential property by up to one-third if, after January 1, 2009, the transferor has installed an active solar system or made seismic retrofitting improvements or improvements utilizing earthquake hazard mitigation technologies; (3) expanding the definition of "realty sold" to include the transfer of controlling interests in entities owning real property; and (4) applying transfer tax to transfers of leaseholds of 35 years or longer. These changes are effective as of December 19, 2008. The basic thrust of the changes is to impose the real property transfer tax on any transaction that also triggers a reassessment of the property for annual real property tax purposes.
Increase in Transfer Tax Rate. The City imposes a transfer tax on transfers of real estate located within the City and County of San Francisco. The transfer tax rate varies based on the value of or consideration received for the realty transferred. Under the prior law, the rates ranged from 0.5% to 0.75% (depending on the value of or consideration for the transferred real estate). Code § 1102 has been amended to increase the transfer tax from 0.75% to 1.5% if the value of or the consideration for the transferred real estate is $5 million or more. The tax rates for transfers of real estate for less than $5 million were not changed.
Although this increased tax rate will not impact the majority of residential transfers, the change will add significant costs to many commercial real estate transfers as many of these transactions involve the transfer of real estate with values of $5 million or more.
Expanding Application of Transfer Tax to Certain Transfers of Ownership in Legal Entities. Code § 1114 was amended to expand the definition of "realty sold" to include "any acquisition or transfer of an ownership interest [in a legal entity] that would be a change in ownership of the entity's real property under California Revenue & Taxation Code § 64" (e.g., a transfer that would prompt a Proposition 13 reassessment). In the partnership context, prior to this change, only transfers that resulted in a technical termination of a partnership would result in the imposition of transfer tax (e.g., transfers of 50% or more of the interests in a partnership or LLC within a 12 month period). As a result of the expanded definition of "realty sold" to include any transfer that would prompt a Proposition 13 reassessment, transfer tax will apply to certain transfers of ownership in legal entities that would have previously not been subject to transfer tax.
For example, prior to this change, when a 49% owner of an LLC that owned real property purchased an additional 2% (going from a 49% owner to a 51% owner), such a transaction would trigger a reassessment for property tax purposes but not a transfer tax obligation. The prior rule more or less required a sale of 50% or more of LLC interests in a 12-month period for a transfer tax to apply. As such, under prior law, but not the newly enacted law, a 49% owner of an LLC could acquire an additional 49% (becoming a 98% owner) without triggering a transfer tax obligation. As a result of the expanded definition of "realty sold," a modest 2% transfer to an existing 49% owner will also trigger a transfer tax obligation.
The expansion of the definition of "realty sold" will result in transfer tax applying to corporate acquisitions having little or nothing to do with San Francisco real estate (e.g., transfer tax will apply where a shareholder acquires greater than 50% of a corporation even if the corporation only holds a nominal amount of San Francisco real estate in proportion to its other assets).
Transfer Tax Now Applies to Transfers of Leaseholds with a Term of 35 Years or More. Finally, Code § 1108.3 was amended to apply transfer tax to transfers of leaseholds with a term of 35 years or more. Prior to this change transfer tax only applied to transfers of leaseholds with a term of 50 years or more.