When I spoke with Ken Weissenberg about the appeal of GKK 2 LLC for its real estate transfer tax, his best comment was that taxes, like ogres, are like onions.
Ken is a partner in charge of EisnerAmper’s real estate services group. He seemed like the right person to ask about this decision being both a lawyer and CPA. He also indicated that he’s been around long enough not to be too specialized, which might be the lesson in this case, because taxes are like, you know, onions.
Three million in transfer duties
The stakes were quite high. GKK was seeking a refund of over $3 million (including interest). Sounded like a lot to me for real estate transfer tax, but that was the Big Apple where real estate transfer tax can be as high as 2.5%. And there was an iconic building involved – 2 Herald Square (also known as 1328 Broadway and the Marbridge Building). It is precisely the Herald Square that George M. Cohan wanted to be remembered.
A creative agreement 1031
The LLC was an overlooked entity owned by Gramercy Capital Corp. (GCC is now known as Gramercy Property Trust, Inc.) GKK acquired a 45% interest in the building in 2007. The remaining 55% was acquired by SL Green Realty Corp, which had acquired 100% of a leasehold interest. The arrangement referred to in this story as a joint venture was not considered a partnership between the two entities. The co-ownership structure (sometimes referred to as tenancy in common) was likely dictated by the interest being a 1031 target (like-kind exchange) as noted in this release.
Andrew Mathias, Chief Investment Officer of Gramercy Capital Corp. and SL Green, said, “Our success in Manhattan is due to our extensive network in the real estate community and our proven ability to creatively structure value-added situations for buyers, sellers and In this acquisition, we have connected with Sitt Asset Management, a savvy New York City real estate investor with whom SL Green has transacted on several occasions, and designed and executed a transaction in which the joint venture and Sitt were able to fit 1031 exchanges in tax free. We believe this acquisition in particular will provide secure debt-like returns with upside equity potential.
I have to tell you, the transaction just seems a bit dodgy to me. The co-owner owns a 100% leasehold interest in the underlying property, so the 45% interest seems to behave much more like debt than equity in real estate, but it’s not what it is about.
Content and form
In 2010, SL Green bought out Gramercy’s stake in 2 Herald Square as part of a larger deal. Well, that’s how the real estate press says it, but for tax people, here’s what really happened. On December 22, 2010, GKK2 LLC contributed its 45% stake to the new company 2 Herald Owner LLC. SLG 2 LLC did the same with its 55% stake. Assuming 2 Herald Owner LLC did not elect to be taxed as a corporation (which is extremely unlikely in these circumstances), a partnership now exists. That’s probably a decent enough interval since the acquisition to not cast doubt on the exchange in 2007.
It turns out that the new partnership (for income tax purposes) was very short-lived. Also on December 22, 2010, GKK2 LLC sold its 45% interest in 2 Heald Owner LLC to SLG2 LLC. To have a partnership, you must have partners (plural), so 2 Herald Owner LLC has been turned, most likely, into an ignored entity. What gives me a serious headache is wondering if 2 Herald Owner LLC needed to file Form 1065 for its fleeting existence as a partnership. In my experience, none of the deal meisters who designed all of this would have thought of that. There is a significant gap between the people who design the structures and those who actually deliver the returns. I used to think you had to do better when it came to nine-figure deals, but my brief tenure with a national company makes me suspect otherwise.
Stepless Transaction Doctrine for Transfer Taxes
Believe it or not, these extra steps don’t seem to have any income tax implications. By converting what was, for income tax purposes, an interest in real property into an interest in a partnership, Gramercy was unable to effect a similar exchange. The additional steps were for transfer tax purposes. If it made a difference for federal income tax purposes, the IRS might have turned the transaction into a sale, just as the real estate press reported. Another story for transfer rights, however. To follow.
The first step was the transfer of the co-tenancy interest to 2 Herald Owner LLC. There is no argument there.
The Division concedes that Petitioner’s contribution of its 45% common interest to Owner LLC in exchange for a 45% interest in Owner LLC, and SLG’s contribution of its 55% common interest to Owner LLC in exchange for A 55% interest in Owner LLC, on its own, is exempt from RETT as a mere change in the form of ownership. Indeed, the Division’s own regulations provide that the RETT does not apply to “[t]a transfer by tenants in common of their interest in an immovable to a partnership or a corporation, the interests of the partnership or corporation being in the same proportionate shares as the tenants in common held before the transfer. Such a transfer is not taxable as there is no change in beneficial ownership”
What New York wanted to do was apply something like the step-dealing doctrine.
The Division attempts to “bundle” three non-taxable transactions, namely (1) the transaction between SLG and Owner LLC, which effected a simple change in the form of ownership, (2) the transaction between the Petitioner and Owner LLC, which effected a simple change in the form of ownership, and (3) the transaction by which the plaintiff transferred its 45% interest in Owner LLC to SLG, in order to impose a tax under the RETT on the transfer of a minority interest . However, the third transaction does not meet the definition of a transfer of a “majority interest” because the petitioner did not own more than 50% of Owner LLC. As such, this transaction, by definition, cannot be considered a transfer or acquisition of a controlling interest in an entity with an interest in real property.
The court did not buy it. Their message to the Tax Division was a longer version of Reilly’s First Tax Planning Law – It is what it is. Go with it.
The issue here does not involve an understanding of physical or social science, arcane regulatory practices, complex markets or industries, expert analysis of voluminous factual data, or subtle political decisions beyond the competence of ordinary people. Indeed, the stakes are of such a purely legal nature that the parties have clarified the facts and submitted the case without a hearing. The Division’s interpretation here is inconsistent with the plain language of the statute, regulations, and its own publication and, as such, is not entitled to deference.
LLC is not always the right answer
Ken Weissenberg told me that this is an illustration of what he has said over the years about holding joint tenancy interests through LLCs. But don’t forget the onions. He also told me about a couple who were denied favorable real estate tax rates on their co-op apartment because they owned it through an LLC. I recently wrote about a New Jersey school that lost its property tax exemption.
The people who designed these transactions were quite astute and I have to take my hat off to them. 2.5% may not seem that high. But you have to remember that it is on the total value of the real estate interest, including the part that is leveraged. That would have taken away quite a bit of the “debt-like” return that the 1031 acquisition was supposed to achieve. The planner’s ability to dig deeper into federal income tax issues and maintain his position shows a very good job. An illustration of Reilly’s Fifth Law of Tax Planning – “A tax plan that ignores SALT’s AMT is not really a tax plan.” SALT stands for State and Local Tax, a specialty that is quite underrated.
If someone told me that the planners had determined in advance if a one day return was necessary for 2 Herald LLC, I would be really impressed because almost no planner follows the ninth law – “Tell the preparer what the plan is.”