We're structuring a complex sale-and-leaseback of a Manhattan property: the seller sells the land and building to a master lessor and separately sells the remainder interest in the land to another buyer, and then leases the whole thing back through a chain of a master lease, a sublease back to the seller, and a possible future ground lease -- with purchase options built in at multiple levels. Which pieces of this get taxed under the Real Property Transfer Gains Tax, and how is 'consideration' calculated for the leases themselves?

Plain-English summary

This tax no longer exists. New York's Real Property Transfer Gains Tax (former Article 31-B of the Tax Law) was a 10% tax on the GAIN from transferring New York real property where consideration was $1 million or more. It was repealed for any transfer occurring on or after June 15, 1996. This 1985 opinion is preserved here for historical and research value, not as current law.

Metromedia, Inc. owned a property at 205-15 East 67th Street in Manhattan and structured a multi-party sale-and-leaseback: Metromedia would sell a 22-year estate for years in the land plus the fee interest in the improvements to Branford Associates Limited Partnership (the "Master Lessor"), and separately sell the remainder interest in the land to Katella Realty Corporation (the "Remainderman") -- together at the property's full fair market value. The Master Lessor would then lease the whole property to RM Branford Corporation (the "Sublessor"), which would in turn sublease it right back to Metromedia. If the Sublessor ever exercised its first renewal option, a further "Ground Lease" from the Remainderman to the Master Lessor would kick in. All the leases were structured as long-term net leases (20-22 year initial terms with multiple 3-7 year renewal options), each containing a purchase option letting the tenant eventually buy back the underlying interests at fair market value. Metromedia asked how the gains tax applies across this whole layered structure.

The Department explained that the Legislature intended the gains tax to hit a sale-and-leaseback only on its SALE aspect, not to also treat the leaseback itself as an independent full-value taxable transfer. Applying that: (1) Metromedia's initial sale of the estate for years/improvements to the Master Lessor, and of the remainder to the Remainderman, is fully taxed on the gain (fair market value minus Metromedia's original purchase price); (2) for the LEASE and SUBLEASE (which do count as consideration for a "transfer" including the option to purchase), the taxable consideration is the PRESENT VALUE of the net lease payments -- here, discounted at 12.14%, a rate the Department found justified by the facts, using "net rent" that excludes taxes/insurance/utilities pass-throughs; because the reversionary interest was assumed to have only nominal value, this present-value approach produced little or no additional gain on the Master-Lessor-to-Sublessor leg; (3) for a sublease entered before September 4, 1984 (Chapter 900 of the Laws of 1984's effective date), the old rule measuring consideration as the present value of the DIFFERENCE between sublease and lease payments applied, and the parties represented that difference would be under $1,000,000 (so pre-9/4/1984 subleases would escape the tax entirely); post-9/4/1984 subleases instead use the full present value of sublease payments, unreduced by lease payments; and (4) if a purchase option is later exercised, the buyer's/lessor's original purchase price for gains-tax purposes on that eventual transfer includes the amount originally paid, plus later capital improvements, plus any gain already recognized on the earlier lease transfer (a Chapter 900 rule applying only to post-9/4/1984 transfers, to prevent double-taxing the same economic gain).

What this means for you

Real estate developers and REITs structuring sale-leaseback financings

A sale-leaseback's SALE leg gets taxed in full at fair market value, but the leaseback itself (even with an embedded purchase option) is taxed separately and typically much more lightly -- on the present value of net lease payments, not the property's full value -- as long as the reversionary interest retained is nominal.

Corporate tax attorneys drafting multi-tier lease/sublease/ground-lease structures

The September 4, 1984 effective date of Chapter 900 (Laws of 1984) is a hard dividing line for how sublease consideration is computed: pre-1984 subleases use only the DIFFERENCE between sublease and lease payments (often producing a much smaller taxable amount), while post-1984 subleases use the full undiminished sublease payment stream.

Accountants computing gain on a later purchase-option exercise following a sale-leaseback

Watch for the Chapter 900 basis-adjustment rule: when a purchase option is eventually exercised (for post-9/4/1984 transfers), the buyer's original purchase price bumps up by any gain already recognized and taxed on the earlier lease transfer -- preventing the same economic gain from being taxed twice across the lease-then-buyback sequence.

Common questions

Q: Does this sale-leaseback gains-tax framework still matter today?
A: Not under this specific tax -- it was repealed for transfers on or after June 15, 1996. Current tax law would need its own separate analysis of a similar structure.

Q: Why is a 12.14% discount rate used to value the lease payments?
A: The opinion states this rate was justified "by the facts" of the specific transaction (i.e., tied to the actual economics the parties presented) -- it's not a generally fixed statutory rate, so a different deal would likely need its own supportable discount rate.

Q: Why does the pre/post-September 4, 1984 distinction matter so much?
A: Chapter 900 of the Laws of 1984 changed how sublease consideration is computed (full sublease-payment present value instead of just the difference versus the head lease) and added the rule letting recognized lease gain increase a later purchase-option buyer's original purchase price -- both rules apply only prospectively from that date.

Q: Can another party structuring a similar sale-leaseback rely on this exact ruling?
A: No, apart from the repeal -- an Advisory Opinion binds the Department only as to the petitioner and facts presented, and the specific discount rate and valuation conclusions here were tied to this transaction's particular numbers.

Citations and references

Statutes and regulations:

• former Tax Law § 1440.7 (definition of "transfer of real property")
• former Tax Law § 1440.4 (definition of consideration)
• Chapter 900, Laws of 1984, effective September 4, 1984 (changed sublease consideration computation from the lease/sublease payment DIFFERENCE to the full sublease payment present value; added the rule letting a lessor add previously recognized/taxed lease gain to original purchase price on a later purchase-option transfer)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/real_prop_tran_ao_1985.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/real_property/a85_1r.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-85 (1) R
Real Property
Transfer Gains Tax
June 20, 1985

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. M831019B

On October 19, 1983, a Petition for Advisory Opinion was received from Metromedia, Inc.,
1 Harmon Plaza, Secaucus, N.J. 07094; RM Branford Corporation c/o Blyth Eastman Paine Webber
Incorporated, 1221 Avenue of the Americas, New York, N.Y. 10020; Branford Associates Limited
Partnership, c/o Gaston Snow & Ely Bartlett, One Federal Street, Boston, Mass. 02110 and Katella
Corporation, c/o Blyth Eastman Paine Webber Incorporated, 1221 Avenue of the Americas, New
York, N.Y. 10020.
The issue raised is whether the real property gains tax imposed under Article 31-B of the Tax
Law is imposed on a long-term net lease, and on a purchase option contained in such lease, where
(i) the lease is entered into as part of a simultaneous sale and leaseback transaction, (ii) the sale price
of the property in question represents the fair market value of such property and (iii) the real property
gains tax is payable in full on the sale of the property.
The pertinent facts are as follows. The parties to the transaction are contemplating entering
into a simultaneous sale and leaseback of the land and improvements known as 205-15 East 67th
Street, New York, New York (hereinafter collectively the "Property"). The transaction will include
the following steps:

1. Metromedia, Inc. (hereinafter "Metromedia") will sell to Branford Associates Limited
   Partnership (hereinafter "Master Lessor") an estate for 22 years in the land (hereinafter the "Estate
   for Years") and the fee interest in the improvements.
2. Metromedia will sell the remainder interest in the land (hereinafter the "Remainder
   Interest") to Katella Realty Corporation or an affiliate or subsidiary thereof (hereinafter the
   "Remainderman"). The aggregate purchase price for the Estate for Years, the fee interest in the
   improvements and the Remainder Interest will be the fair market value of the Property.
3. The Master Lessor, as lessor, will enter into a lease of the Property (hereinafter the
   "Lease") with RM Branford Corporation (hereinafter the "Sublessor"), as lessee.
4. The Sublessor, as lessor, will enter into a sublease of the Property (hereinafter the
   "Sublease") with Metromedia, as lessee.
5. The Remainderman, as lessor, will enter into a lease of the land (hereinafter the "Ground
   Lease") with the Master Lessor, as lessee. The Ground Lease will become effective only if the
   Sublessor exercises or is deemed to have exercised, its first renewal option under the Lease (see
   following paragraph).

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

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TSB-A-85 (1) R
Real Property
Transfer Gains Tax
June 20, 1985
The initial terms of the Sublease and Lease will be 20 years and 22 years respectively.
Metromedia will have options to renew the Sublease for seven renewal terms of five years each; the
Sublessor will have options to renew the Lease for a first renewal term of three years and for six
subsequent renewal terms of five years each. The initial term of the Ground Lease will be three
years, with options to renew for twelve renewal terms of five years each. If Metromedia exercises
a renewal option under the Sublease, the Sublessor will automatically be deemed to have exercised
the corresponding renewal option under the Lease. If a renewal option under the Lease is so deemed
exercised, or if the Sublessor itself exercises one of such renewal options, (i) the term of the Ground
Lease will commence (in the case of the first such renewal option) or (ii) the corresponding renewal
option under the Ground Lease will automatically be deemed exercised (in the case of the second
through seventh of such renewal options).
The Lease will give the Sublessor an option (hereinafter the "Purchase Option") to purchase
the improvements and the Estate for Years from the Master Lessor at the end of the initial term of
the Sublease and at the end of any renewal term of the Sublease. The Purchase Option will be
assigned to Metromedia under the Sublease. If Metromedia exercises the Purchase Option, the
Remainderman and the Sublessor will also be obligated to convey their interests in the Property to
Metromedia. The total option price for the Property will be its fair market value, determined as if
all renewal options under the Sublease, Lease and Ground Lease were exercised and the Property
were sold subject to such leases.
The Sublease, Lease and Ground Lease also provide a mechanism pursuant to which
Metromedia can be compelled to repurchase the Property at a pre-established price in the event the
Property is condemned or substantially destroyed by casualty or in the event Metromedia can no
longer conduct business economically on the Property.
The Sublease, Lease and Ground Lease will each be "net leases," with the lessee thereunder
obligated to pay all expenses associated with the use and operation of the Property. The lessee is
also permitted to make capital improvements to the Property.
Net rent under the Sublease (i.e., the fixed rent payable by Metromedia, not including
payments made on account of real estate taxes, insurance, utilities and similar expenses), when
discounted at a rate of approximately 12.14%, will equal the original purchase price for the Estate
for Years and the improvements. During the first five years of the initial term of the Lease and
Sublease, net rent payable under the Lease will be slightly greater than that payable under the
Sublease; during the remainder of the term, net rent under the Lease and Sublease will be equal. The
difference between the net rent payable under the Lease and Sublease, when discounted at a rate of
approximately 12.14% will be less than $1,000,000.
It was the intent of the Legislature to subject a simultaneous sale and leaseback to the gains
tax imposed under Article 31-B of the Tax Law only on the sale aspect of the transaction. This intent
is realized through the following application of the gains tax to the transactions described herein.

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TSB-A-85 (1) R
Real Property
Transfer Gains Tax
June 20, 1985
First, the transfer by Metromedia to the Master Lessor of the Estate for Years and the fee in
the improvements is fully subject to the gains tax on the difference between the consideration, which
equals the fair market value of the property, and Metromedia's original purchase price in the
property. Similarly, the gain on the sale of the remainder interest to the Remainderman for the fair
market value of this interest is subject to the gains tax.
Secondly, with respect to the transfers of the Estate for Years in the land and the fee in the
improvements, the consideration to the Master Lessor for the Lease, which includes the Option to
Purchase, is the present value of the lease payments. It is appropriate to utilize a net rent amount to
determine the present value of the lease payments. Net rent means the amount payable by the
Sublessor for the use of the property, excluding payments for real estate taxes, insurance, utilities
and similar expenses. Further, the facts justify the use of a discount factor of 12.14% to calculate
the present value of the lease payments. The Master Lessor may allocate his original purchase price
of the property between the value of the lease interest and the value of the reversionary interest.
Assuming that the reversionary interest has a nominal value, this method of analyzing the lease
transaction will result in little or no gain on this transfer from the Master Lessor to the Sublessor.
If the Sublease occurred before September 4, 1984, the rules in effect at that time defined the
consideration for the Sublease as the present value of the difference between the Sublease payments
and the Lease payments. Petitioner states that consideration defined in this manner would be less
than $1,000,000. Accordingly, if the Sublease occurred before September 4, 1984 it would not be
subject to the gains tax. If the Sublease occurred after September 4, 1984, the effective date of
Chapter 900 of the Laws of 1984, the consideration for the Sublease would be the present value of
the Sublease payments, unreduced by the present value of the lease payments.
The Ground Lease, if effective, from the Remainderman to the Master Lessor must be
analyzed in the same manner as the Lease. The consideration for the Ground Lease is the present
value of the lease payments due under it. Again, it is appropriate to determine the present value of
the lease payments by using the discount factor of 12.14% and utilizing the net rent amount. The
Remainderman may allocate his original purchase of the remainder between the value of the interest
leased and the value, if any, of the reversion.
Finally, if Metromedia exercises its purchase option to purchase the Estate for Years and the
fee in the improvements, the original purchase price of the Master Lessor on this transfer will be the
amount the Master Lessor paid for these interests when he acquired them, plus the cost of any capital
improvements made by the Master Lessor to the property after the granting of the lease; plus the gain
recognized, if any, by the Master Lessor on the Lease. This increase in original purchase price for
any recognized gain on the prior lease was authorized by Chapter 900 of the Laws of 1984 and would
only apply to transfers after September 4, 1984.

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TSB-A-85 (1) R
Real Property
Transfer Gains Tax
June 20, 1985
The original purchase price of the Remainderman on the transfer of the remainder to Metromedia
will likewise be the amount the Remainderman paid to acquire the remainder interest plus any gain
recognized on the Ground Lease by the Remainderman.

DATED: May 9, 1985

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth herein.