Businesses in Florida that hold real property and business operations in separate entities for liability planning purposes should be aware of a tightening of a position by the Department of Revenue regarding the sales tax ramifications of such an arrangement.
Florida imposes its sales tax (between six and seven percent, depending on the county) on rent paid on real property leases, even where the landlord and the tenant are related parties (and even where they are disregarded entities for federal income tax purposes). So, a lease arrangement between a corporation and its 100 percent subsidiary, or between an LLC and its sole member, would be subject to Florida sales tax, resulting in a tax cost for the liability protection of segregating real estate ownership and business operations in separate related entities.
Five years ago the Florida Department of a Revenue (DOR) published a private letter ruling, TAA 04A-061 that indicated a somewhat liberal reading of this rule, concluding that there would be no imputed rent on which sales tax would be due if:
- There is no obligation of the operating business entity( "Operating Entity") to pay rent or any expenses of the real property to the real property owner entity ("Owner Entity”);
- The profit distributions from the Operating Entity to the Owner Entity do not coincide with the timing of expense payments on the real property (such as mortgage and real estate tax payments);
- The amount of the profit distributions from the Operating Entity do not coincide with the amount of the property's expenses; and
- The persons controlling the amount of the profit distributions from the Operating Entity base the amount of the distribution on the true income of the Operating Entity.
Although TAA 04A-061 is binding only to the taxpayer who requested it, it was an indication of the DOR's position at that time, and some businesses may have structured real estate use arrangements between related entities using this prior ruling as a guide.
However, in a new ruling, TAA 09A-048, the DOR appears to have tightened or even retreated from its earlier position. This new ruling discusses a situation where the Owner Entity and the Operating Entity are affiliates, owned by the same person. The real estate use arrangement did not provide for a written lease (although it appears that a license arrangement existed between the two entities). The new facts present in this ruling not evident in the prior ruling are that the Owner Entity entered into a loan arrangement with a third party lender, executing a mortgage, assignment of rents, and UCC-1 financing statement in connection with assignment of rents. In addition, both the owners of Owner Entity as well as Operating Entity executed guaranties of the loan. Furthermore, the Owner Entity's income tax returns said that it was engaged in the business of real estate rentals.
The Owner Entity funded all of the properties expenses with contributions to capital from its members, which they, in turn, had received from the Operating Entity. The Owner Entity requested a ruling that no sales tax would be due on this arrangement. But the DOR declined to rule favorably, and concluded that the arrangement was subject to sales tax, based on the amount of the real property's expenses, even though the arrangement appears to have fit in the requirements set out in prior rulings. What appeared to make the difference in this new ruling is that the loan documents with the third party lender provided for an assignment of rents, the Operating Entity guaranteed the loan, and the Owner Entity's income tax return stated that is was engaged in the business of real estate rental. These facts resulted in the conclusion that a real estate lease arrangement was intended, with the expectation that the profit distributions from the Operating Entity would be adequate to fund the real estate expenses, after they were contributed to the capital of the Owner Entity.
Businesses that have segregated Florida real estate ownership and business operations in separate entities (or considering it) should carefully review this new ruling to see if they share any common facts with the situation discussed in the ruling in order to determine if their arrangement might be subject to Florida sales tax on imputed rent. They might also want to consider submitting their own ruling request.