NYS gains tax changes affecting developers

Real Estate Weekly, July 20, 1994

Most real estate owners and developers are generally aware of the recently enacted REIT provisions of the new York State Real Property Transfer Gains Tax, which sharply reduce the tax rate on transfers made in connection with the formation of a REIT. However, in addition to the REIT provisions, several other changes affecting the computation of gain subject to tax are effective for transfers on or after June 9, 1994. These changes, along with those previously enacted April 15, 1993, are the State's response to the real estate industry's call for fairness as to the imposition of the New York State Real Property Transfer Gains tax.

In 1993, New York State amended the definition of original purchase price (OPP) to include certain costs which previously were not allowed. OPP is subtracted from consideration in computing the gain subject to tax. The newly allowed costs included any customary, reasonable and necessary advertising and marketing costs (not included in brokerage fees), mortgage recording taxes, interest on acquisition loans during construction and Section 421-A costs.

The 1994 amendments further expand the definition of OPP to include State and local transfer taxes paid or required to be paid by the transferor upon the transfer of the property and a portion of certain lease-up costs such as brokerage fees (includable to the extent of the unexpired term of the lease or sublease as of the date of transfer).

In addition, the definition of construction period, the determination of which has always been an issue raised on audit, has been expanded. The expanded definition of construction period will allow a transferor to include in OPP certain costs, such as interest and real estate taxes, incurred prior to the start of physical construction. Under the new definition, the construction period commences when the transferor begins to actively pursue the plan of construction, development or rehabilitation, not when physical construction begins. Examples of activity to support the commencement of the construction period include authorizing the preparation of architectural plans or feasibility studies, seeking zoning approvals and building permits, retaining contractors, arranging for funds for payment of construction costs, arranging for demolition of existing structures, and conducting soil tests or other engineering studies. The overall actions of the transferor must demonstrate that the transferor has begun to actively pursue a plan of construction. The fact that the transferor has undertaken any one of the foregoing activities in and of itself does not demonstrate that the construction period has begun.

The end of the construction period is now based on the final use or disposition of the property. If the property is held by the transferor for its own use, then the construction period would end when the property is ready to be placed in service. For property constructed, developed or renovated with the intent to resell or lease, the construction period would end when the property is sold or leased.

Sponsors of cooperatives and condominiums should be aware that a portion of these costs previously incurred will now be permitted to be included in their OPP computation on a prorated basis.

The 1994 amendments include provisions for a builder's exemption, which provides for a full or partial exemption from gains tax if a capital improvement has been constructed during a specified period of time. To qualify for the exemption, the construction of the capital improvement must have commenced between January 1, 1994 and January 1, 1996 and must be distinct and separate from any improvement started before January 1, 1994.

Another provision amends the rules regarding consideration to be aggregated on the sale of subdivided parcels. Under prior law, the sale of subdivided lots was aggregated to determine the $1 million consideration threshold unless the lots were improved and sold to transferees for use as their residences. The new rules provide that consideration from the transfer of parcels located in a residential subdivision will not be aggregated where the parcels have been substantially improved for residential use and are being transferred to transferees who intend to construct residential dwellings.

(Larry Weiser, a partner with the accounting firm of Friedman Alpren & Green, has extensive experience dealing with all aspects of the New York State Real Property Transfer Gains Tax and is happy to answer any questions you may have.)