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Ohio Legislature Attempts Once Again to Enact New Law to Close Real Estate Tax Loophole

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By James E. Peters

February 4, 2020

Recently in Ohio it has been common practice to structure large commercial real estate transactions as “drop and swap” or “LLC drop-down” transactions.   In these types of transactions, the owner of a piece of improved real estate will create a new limited liability company and transfer the real estate into this new LLC directly prior to closing.  At the time of this initial transfer of the real estate, the prior owners will continue to own the membership interests in the new LLC. Therefore, the transaction can be properly recorded as an exempt transaction under Ohio Revised Code §319.54 and further exempt from the county auditor’s conveyance fee.  This is the case because no consideration is exchanged in the initial transaction since the owners of the real estate will continue to be the owners of the new LLC.  Immediately after the new LLC takes title to the real estate, the members/owners of the LLC interests will enter into Membership Interest Purchase Agreement to sell the ownership interests in the new LLC to the buyer(s).

The transfer of the real estate to the new LLC is exempt from the county conveyance fee because no consideration changes hands in the initial real estate transfer, no Form DTE 100 (Real Property Conveyance Fee Statement of Value and Receipt) is required to be filed.  

Sellers and Buyers of real estate throughout the State of Ohio have routinely structured transactions in this manner to avoid the county conveyance fee (which is typically assessed at $4 per thousand dollars of the purchase price)  and to defer the change in taxable value of the real estate in question.   The deferral of the taxable value of the real estate is achieved in those situations where the purchase price being paid by the buyer greatly exceeds the tax assessed value of the subject real estate as determined by the auditor  of the county in which the subject real estate is located.  The benefits in structuring the sale in this manner are realized by both sides of the transaction as the seller typically pays the conveyance fee and the buyer will save the increased real estate tax assessment amount.  The benefits bestowed to the buyer and seller in these transactions are to the detriment of county auditors and school districts in the locales where the real estate is located.

Back in 2018, the Ohio House of Representatives proposed legislation to close this loophole, but the House Bill never passed into law and the “drop and swap” – “LLC drop down” transactions continued.   Today, Ohio is one of only a few states remaining where a party could effectuate this type of real estate transaction and avoid both the increase in the real estate’s taxable value and the conveyance fee.   On December 17, 2019, representatives from the Ohio House introduced H.B. 449, which seeks to permanently close this loophole. 

The proposed legislation mandates disclosures to local taxing authorities when a transaction involves a conveyance/transfer of more than 50% of the membership interests in the so called “drop-down” or “pass through” LLC, which directly or indirectly owns real estate within the State of Ohio.   The subject transfer may occur in one or more transactions which occur within a one-year duration of each other, preventing circumvention schemes being implemented through a series of separate transactions.   The mandated disclosures require the seller/grantor to execute and submit a written statement declaring all of the following: (i) the total amount paid to the seller/grantor as consideration for the sale of the  LLC membership/ownership interests; (ii) the portion of that total which is allocated to real property owned directly or indirectly by the LLC; (iii) the percentage of the ownership interest in the LLC being transferred; and (iv) with respect to the real estate owned indirectly by the LLC in which membership/ownership interests are being transferred, the LLC’s percentage of ownership interest in the person that directly owns the real property.   This disclosure statement would be provided/filed with the county auditor’s office in the locale where the real estate in question is located.  The information contained in the disclosure statement would be utilized to reassess taxable values of the subject properties.  It is unquestioned that local school boards and their attorneys will be critically reviewing these statements.

The new legislation also proposes two new levels of fees and taxes for qualifying transactions: (i) a real estate tax will be assessed on the transfer of ownership interests at the rate of 30 cents for every $100 of the value of the real property; and (ii) a conveyance fee would be assessed at the rate of 10 cents for every $100.   There are also significant penalties imposed for parties who attempt to avoid or fail to timely pay the tax or fees.

Reminger Co., L.P.A. will continue to monitor this proposed legislation and supplement this Reminger Report when and if necessary.  As indicated earlier, this is not the first time that legislation has been proposed in an attempt to capture and tax these types of “drop and swap” or “LLC drop-down” transactions, so it is speculative whether H.B. 449 will garner the necessary support to be enacted into law.

If you have any other questions related to this proposed legislation, feel free to contact a member of our Real Estate or Corporate & General Business Practice Groups.

This has been prepared for informational purposes only. It does not contain legal advice or legal opinion and should not be relied upon for individual situations. Nothing herein creates an attorney-client relationship between the Reader and Reminger. The information in this document is subject to change and the Reader should not rely on the statements in this document without first consulting legal counsel.

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