Transfer tax reforms promise a stronger market

Real Estate Weekly, June 22, 1994 by Steven Spinola

After the longest realty recession in memory, we are headed for better times at last. Some of the slowly evolving recovery can be traced to inevitable adjustments in supply and demand, but this trend will gather increasing force in the months ahead for another reason. Thanks to Governor Cuomo and his staff, backed by the state legislature and supported by the Giuliani administration, REBNY's call for reduced anticompetitive transfer taxes on real estate investment trusts (REITs) has been heeded.

Disproportionately high taxes on transactions had discouraged the formation of these crucial financing vehicles in New York. Our success at lowering some of those levies is of enormous importance because REITS have become a leading source of capital for realty ventures across the nation, providing approximately $11 billion in funds over the past year. With REIT financing available, building renovation and construction programs, long stalled by the credit crunch, can go forward. The case we made to the governor, state Economic Development Commission Vincent Tese, and Taxation and Finance Commissioner James Wetzler stressed that REITs would replace real estate debt with equity, return funds to lending institutions that could be used to fuel economic growth, and generate jobs and revenue through improving the real property tax base.

To qualify for the preferential tax treatment the entity forming the REIT must commit 75 percent of its funds to capital improvement programs, debt reduction, and leasing or acquisitions. The remaining 25 percent can be used for fees and associated costs. In addition, the seller of the real estate must maintain at least 40 percent of die value of the equity interest in the realty for at least two years.

Here are the key portions of the state budget resolution:

- The state gains tax on REITs goes from 10 percent of the difference between consideration and the original purchase price down to 2.5 percent.

- The state transfer tax on the value of the property as determined for gains tax purposes is lowered from four percent of gross value to two percent, and

- The city transfer tax is cut from 2.625 percent of gross value by half.

At REBNY's recommendation as well, a mere change in the form ownership--from a partnership to a corporation, for example--will not be subject to the New York City transfer tax. This new permanent. provision applied to all transfers, including those into a REIT.

In addition, Albany also adopted an exemption shielding the value of improvements made until the end of 1995 from gains tax liability on the first sale following the improvement's completion.

This year's reforms complement gains tax actions taken in the prior state legislative session. At that time, REBNY representatives convinced the governor's office and the leadership of both houses to grapple with that levy's administrative inequities. This transfer tax was intended to be based on true economic gain, but since so many legitimate and customary business expenses had been excluded in calculating profit, it was possible to lose money on a venture and still be liable for gains payments. In fact, such cases occurred. Among the defects rectified by state included the addition of "soft costs" of advertising and marketing expenses, mortgage recording taxes, interest on land during construction and the amortized cost of 421(a) certificates on the sold cooperative and condominium units to the original purchase price.

Another important correction we sought and won was a redefinition of consideration on transfer of a troubled property to the lender as its appraised fair market value. Before this reform, consideration was set as the fixed amount of the debt. Since that amount often exceeded the fair market value--especially in the trough of the real estate recession--properties were tumbling back to lenders prematurely.

Mindful of the problems that lenders were facing, we persuaded the state that those taking back a troubled property should not be liable for the transferor's gains tax liability arising from a sale. On subsequent sales by lenders of foreclosed property, where the lenders are concerned, computations of the gains tax are now determined according to a basis consisting of the loan amount and other expenses incurred during the foreclosure period prior to sale. Previously, the lender's liability might be imputed from the property's market value between the time of the foreclosure and the subsequent sale.

We also attained a waiver or abatement on gains tax penalties if the failure to pay is attributable to a reasonable cause.

These gains tax reforms, achieved over two years of meetings with senior state officials, have culminated in enhancements that should facilitate the creation of REITs. We are optimistic that these more enlightened policies will serve the state, the city and our industry well as we emerge from a time of trial. We look ahead to more building sales, more properties being upgraded and noteworthy growth in the city's employment base, but these predictions should be examined in the context of current market conditions.