Did one LLC member's acquisition of the other two members' one-third interests trigger Washington REET on only the transferred 67%, or on all LLC real property?

Plain-English summary

The Washington Department of Revenue held that one LLC member's acquisition of the other two members' interests triggered real estate excise tax on the full value of the LLC's Washington real property. Each member originally owned one third. After the other two separately withdrew and transferred their interests during the same month, the remaining member owned 100%.

Washington treats the acquisition within 12 months of 50% or more of an entity that owns Washington real property as a taxable sale. The departing members did not have to act in concert because the statute and rule also reach interests acquired by a single person through multiple transactions.

The LLC argued that tax should apply only to 67% of the property value because that was the additional interest acquired. The determination rejected that approach. For a controlling-interest transfer, the selling price is the true and fair value of all Washington real property owned by the entity, not the consideration paid or the percentage transferred.

Because the LLC did not document the property's true and fair value at the transfer date, the Department properly used the market values on the county property-tax rolls. The refund petition was denied.

What this means for you

LLC owners

Track changes in ownership over a rolling 12-month period. Separate transactions can combine into a controlling-interest acquisition even when different sellers negotiate independently.

Real estate and transaction advisers

Model REET against the full value of the entity's Washington real property once the 50% threshold is crossed. The taxable measure is not limited to the acquired ownership percentage.

Tax and valuation teams

Retain a defensible fair-market-value appraisal or other contemporaneous valuation. Without it, Washington may use county-assessed market values.

Common questions

Q: Did the two sellers need to act in concert?

A: No. The rule required either a single transferor or acquisition by a single person or qualifying group. Here, one remaining member acquired both interests within 12 months.

Q: What percentage constituted a controlling interest in this LLC?

A: At least 50% of the capital, profits, or beneficial interest.

Q: Why was tax measured by 100% of the real property's value?

A: RCW 82.45.030 treats the true and fair value of the entity's Washington real property as the selling price when a controlling interest transfers.

Q: What value did the Department use?

A: Because no reliable current fair-value documentation was supplied, it used the market values maintained on the county property-tax rolls.

Citations and references

• RCW 82.45.010(2)(a) and RCW 82.45.033(1)(b) (controlling-interest sale and threshold)
• RCW 82.45.030(2) and (4) (selling price and county-roll fallback)
• WAC 458-61A-101(3), (4), and (6) (controlling-interest rules and examples)
• McFreeze Corp. v. Department of Revenue, 102 Wn. App. 196, 6 P.3d 1187 (2000)
• Det. No. 98-083, 17 WTD 271 (1998)

Source

• Landing page: Washington Tax Decisions ZIP files
• Original PDF: 35WTD577.pdf
• Source archive: Volume 35 ZIP (member 35 WTD 577.pdf)

Original ruling text

Det. No. 16-0135, 35 WTD 577 (December 1, 2016)

577

Cite as Det. No. 16-0135, 35 WTD 577 (2016)

BEFORE THE ADMINISTRATIVE REVIEW AND HEARINGS DIVISION
DEPARTMENT OF REVENUE
STATE OF WASHINGTON
In the Matter of the Petition for
Refund of

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DETERMINATION
No. 16-0135
Registration No. . . .

[1] RCW 82.45.010; WAC 458-61A-101: REAL ESTATE EXCISE TAX – TRANSFER OF A CONTROLLING INTEREST. Real estate excise tax is due when 50 percent or more of the interest in an entity that owns real property is transferred or acquired within a 12-month period. When multiple transactions occur within a 12-month period, a controlling interest transfer occurs when the interest is either transferred by a single person, or acquired by a single person.
[2] RCW 82.45.030; WAC 458-61A-101: REAL ESTATE EXCISE TAX – CONTROLLING INTEREST TRANSFER – MEASURE OF TAX – McFreeze Corp. v. Dep’t of Revenue, 102 Wn. App. 196, 6 P.3d 1187 (2000). In the case of a controlling interest transfer, the amount of real estate excise tax owed is measured by the fair market value of the real property as a whole, not the value of the interest that was transferred. Headnotes are provided as a convenience for the reader and are not in any way a part of the decision or in any way to be used in construing or interpreting this Determination. Poley, T.R.O. – A limited liability company [(LLC)] that owns real property in Washington protests the assessment of real estate excise tax [(REET)] on the value of the property upon the transfer of two one-third shares in the company to the holder of the remaining one-third share. We conclude that the sole remaining owner of the company acquired a controlling interest, causing imposition of [REET] on the full value of real property owned by the company. The assessment is affirmed.1 ISSUES

1. Does the transfer of two-thirds interest in a [LLC] that owns real property in Washington
   constitute a transfer or acquisition of a controlling interest, triggering the imposition of
   [REET] under RCW 82.45.010 and WAC 458-61A-101?

1

Identifying details regarding the taxpayer and the assessment have been redacted pursuant to RCW 82.32.410.

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2. Is [REET] calculated proportionally to the percentage of interest in real property that was
   transferred under RCW 82.45.030 and WAC 458-61A-101?
   FINDINGS OF FACT
   [Taxpayer] owns seven parcels of real property in . . . , Washington. On July 16, 2015,
   [Manager] submitted a [LLC] renewal and annual report on behalf of Taxpayer (Renewal). The Renewal listed Manager as the sole manager of Taxpayer, and indicated that a controlling interest transfer had occurred in the previous year. Taxpayer did not complete a controlling interest affidavit as required by the Department of Revenue (Department). Shortly thereafter, the Department’s Special Programs Division contacted Manager to obtain information related to the transfer of interest by Taxpayer’s members. The Department learned that Taxpayer was created in 1997 under a [LLC] formation agreement (Agreement). Prior to 2015, Taxpayer was owned in equal one-third shares by Manager, [Member 1] and [Member 2] (together, Members). Manager and Members are related through the marriage of their parents. The Agreement allows a member to withdraw from Taxpayer upon approval from the other members. The Agreement also limits the amount due to a withdrawing member to no more than 50 percent of the value of the member’s interest. According to Manager, on March 8, 2015, [Member 1] contacted Manager and requested to withdraw from Taxpayer. Then, on May 9, 2015, [Member 2] contacted Manager and also requested to withdraw from Taxpayer. Manager negotiated separately with [Member 1] and
   [Member 2], and each agreed to accept $ . . . from Taxpayer in exchange for their interest in Taxpayer. This amount is less than the limit provided for in the Agreement. On June 10, 2015, Manager and Members signed a manager’s consent form, agreeing to
   [Member 1’s] request to withdraw from Taxpayer. Also on that day, Manager and Members signed another manager’s consent form, agreeing to [Member 2’s] request to withdraw from Taxpayer. Manager prepared separate bills of sale for [Member 1] and [Member 2] to each withdraw from Taxpayer in exchange for $ . . . . On June 18, 2015, Members signed their respective bills of sale. Manager mailed separate checks to Members on June 26, 2015. As the sole remaining member, Manager now held 100 percent interest in Taxpayer. The Department determined that [REET] was owed on Taxpayer’s real property upon the transfer of interest from Members to Manager. The Department issued a REET adjusted assessment on October 6, 2015, for $ . . . , which included $ . . . in tax, $ . . . in penalties, and $ . .
   . in interest. [Member 2] paid the amount of the assessment and Taxpayer timely petitioned for a refund. Taxpayer agrees that together, Members transferred a controlling interest during 2015. However, Taxpayer claims that Members were not acting in concert, and therefore the Department should not aggregate the transfer of their interests in determining whether REET should be imposed. Taxpayer also claims that only 67 percent of the value of the property should be subject to REET as Manager only acquired 67 percent interest in Taxpayer as a result of the transfer.

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ANALYSIS
REET is imposed on each sale of real property located within Washington. RCW 82.45.060. RCW 82.45.010(1) defines “sale” to include: “any conveyance, grant, assignment, quitclaim, or transfer of the ownership of or title to real property … for a valuable consideration.” The term “sale” also includes “the transfer or acquisition within any twelve-month period of a controlling interest in any entity with an interest in real property located in this state for a valuable consideration.” RCW 82.45.010(2)(a). In the case of a partnership, association, trust, or other entity, a “controlling interest” means “fifty percent or more of the capital, profits, or beneficial interest in such partnership, association, trust, or other entity.” RCW 82.45.033(1)(b); WAC 458-61A-101(2)(a)(ii). WAC 458-61A-101(3) explains that in order for REET to apply when the controlling interest in an entity that owns real property is transferred, the following must have occurred: (a) The transfer or acquisition of the controlling interest occurred within a twelvemonth period. . . . (b) The controlling interest was transferred in a single transaction or series of transactions by a single person or acquired by a single person or a group of persons acting in concert; (c) The entity has an interest in real property located in this state; (d) The transfer is not otherwise exempt under chapters 82.45 RCW and 458-61A WAC; and (e) The transfer was made for valuable consideration. (Emphasis added.) Taxpayer claims that Members were not acting in concert and the transfer of their interests should not be aggregated. However, as WAC 458-61A-101(3)(b) makes clear, it is immaterial whether sellers of a controlling interest acted in concert; the rule only requires that a group of purchasers acted in concert. Thus, whether Members acted in concert is irrelevant to the outcome of this case. WAC 458-61A-101(6)(d)(ii) contains an example illustrating that REET is owed when a purchaser acquires a controlling interest from multiple sellers within a twelve-month period regardless of whether the sellers acted in concert: Matt acquires a 10% interest in an entity which owns an apartment building under construction worth 500,000 from Simon on January 30th. On July 30th Matt acquires a 30% interest in the same entity from Mary, but the building is now worth $900,000. On September 30th Matt acquires a 10% interest in the same entity from Ruth, but the

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building is now worth $1,000,000. These are three separate and completely independent transfers. The final transfer allowed Matt to acquire, within twelve months, a controlling interest in an entity that owns real property. September 30th is the date of sale. (Emphasis added.) This example specifically involves acquisition of a controlling interest from multiple sellers over a period of time, just as is the case here. Members transferred their interests to Taxpayer in exchange for $ . . . each. At that point, the sole remaining owner, Manager, acquired an additional two-thirds interest in Taxpayer that previously belonged to Members. For this reason, we conclude that Manager acquired a controlling interest in Taxpayer regardless of whether Members acted independently or in concert. Accordingly, we find that Manager’s acquisition of a controlling interest constitutes a “sale” under RCW 82.45.010(2)(a), triggering liability for REET on the value of Taxpayer’s real property. Taxpayer contends that the measure of REET should be proportional to the interest that Manager acquired in Taxpayer. As Manager acquired a 67 percent interest in Taxpayer, Taxpayer argues that REET should be calculated on 67 percent of the value of the real property owned by Taxpayer, not on the full value. However, this argument is not supported by the applicable statutes, rules, and case law. When real property is sold in Washington, REET is imposed based on the “selling price.” RCW 82.45.060. The term “selling price” is defined under RCW 82.45.030. That statute provides, in pertinent part: (2) If the sale is a transfer of a controlling interest in an entity with an interest in real property located in this state, the selling price shall be the true and fair value of the real property owned by the entity and located in this state. If the true and fair value of the real property located in this state cannot reasonably be determined, the selling price shall be determined according to subsection (4) of this section.
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(4) If the total consideration for the sale cannot be ascertained or the true and fair value of the property to be valued at the time of the sale cannot reasonably be determined, the market value assessment for the property maintained on the county property tax rolls at the time of the sale shall be used as the selling price. (Emphasis added.) WAC 458-61A-101(4)(c)(iii) offers a relevant example: An LLC owns real property and consists of two members, Frances and George. Each has a 50% LLC interest. Frances transfers her 50% interest to George. In exchange for the transfer, George pays Frances $100,000. The true and fair value of the real property owned by the LLC is unknown. There is no debt on the real property. A fair market value appraisal is not available. The market value assessment for the property maintained on

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the county property tax rolls is $275,000. The taxable selling price is the market value assessment, or $275,000. The Washington Court of Appeals addressed this issue in McFreeze Corp. v. Dep’t of Revenue, 102 Wn. App. 196, 6 P.3d 1187 (2000). There, the court found that in the sale of a controlling interest of a corporation, partnership, or other entity that owns Washington real property, “the value taxed is not the consideration paid, but the value of the real estate owned by the entity.” Id. at 201, 6 P.3d at 1190. The court went on to explain that “nothing in the statutes authorizes the taxpayer to apportion the tax. . . . If the sale is 49 percent or less of the entity, no tax is owed. But if the sale is 50 percent or more, tax is owed on the full value of the real estate owned by the entity.” Id. Accordingly, the amount of REET at issue here bears no relation to the proportional interest transferred from Members to Manager. Members’ transfer of their interest in Taxpayer is the incident giving rise to the imposition of REET; it does not factor into the measure of REET. See Det. No. 98-083, 17 WTD 271 (1998). Rather, the amount of REET assessed is based on the full value of the real property, not a percentage of the value. Here, Taxpayer did not provide documentation of the true and fair value of its real property at the time of the transfer of a controlling interest, and thus the Department was unable to reasonably determine the property’s value. Therefore, the Department correctly assessed REET on the market values shown for Taxpayer’s real property on the county property tax rolls. DECISION AND DISPOSITION Taxpayer’s petition is denied. Dated this 5th day of April, 2016.