At a Glance…
The California Supreme Court, in a 6-1 decision, has held that a city or county may impose documentary transfer tax on the transfer of the ownership interests in a legal entity that owns real property located in the locality. In 926 North Ardmore Avenue, LLC v. County of Los Angeles,1 the court held that the documentary transfer tax applies to a written instrument conveying an interest in a legal entity that owns real property. This approach adopts the “change in ownership” regime for property tax purposes and applies it to the documentary transfer tax.
The documentary transfer tax is imposed by cities and counties throughout California. It is based on the former Federal Stamp Act, which imposed a tax on deeds for the transfer of real property. The Federal Stamp Act was repealed effective 1966—two years before the California documentary transfer tax was enacted. Drawing on the purpose and language of the Federal Stamp Act, the documentary transfer tax applied to deeds, instruments, or writings by which lands, tenements, or other “realty sold” is granted, assigned, transferred, or otherwise conveyed. Thus, the documentary transfer tax statute was drafted to impose the tax on the direct transfer of property, and not the indirect transfer of ownership interests in entities that own property; and for decades, California cities and counties applied the documentary transfer tax in accordance with the plain language of the statute.
A decade after the documentary transfer tax statute was enacted, California voters approved Proposition 13. Proposition 13 amended the California Constitution to limit the power of California counties to increase the assessed value of real property for property tax purposes in situations where there was no “change in ownership” of the property. Proposition 13 provided that such changes in ownership could occur either as a result of a direct change in the ownership of real property, or an indirect change in the control of an entity or entities owning the property. Of course, a change in direct ownership of property would typically involve the recording of a deed or other document granting, assigning, transferring, or otherwise conveying the property to a transferee. But an indirect change in control of the property would not require the recording of such a document. Starting in the past 10 years, some California cities and counties began imposing the documentary transfer tax on all transactions that would trigger a reassessment of real property for property tax purposes. This expansion of the documentary transfer tax resulted in the imposition of the tax on mere changes in control of an entity that held real estate, even if there was no recording of a deed, instrument, or other writing granting, assigning, transferring, or conveying property. The mere indirect change in control of property was deemed sufficient to impose the documentary transfer tax.
Today, the California Supreme Court issued its decision in 926 North Ardmore Avenue v. County of Los Angeles, holding that cities and counties may impose the documentary transfer tax on transfers of interests in legal entities holding real property when such transfers are treated as a “change in ownership” for property tax purposes under Proposition 13. Thus, the tax applies to a written instrument conveying an interest to a legal entity that owns real property. The court reasoned, “[T]he critical factor in determining whether the documentary transfer tax may be imposed is whether there was a sale that resulted in a transfer of beneficial ownership of real property. The change in ownership rules, though enacted after the Transfer Tax Act, fit squarely into this framework.” The court went on to state that “the change in ownership rules are designed to identify precisely the types of indirect real property transfers that the Transfer Tax Act is designed to tax.” Justice Kruger, in her dissenting opinion, stated that the majority opinion ventures beyond the statute’s language and historical practice. She sought to leave it to the Legislature to expand the scope of the tax if it was so inclined.
The North Ardmore case involved the transfer of a limited liability company that owned real property located in Los Angeles County. The membership interests in the limited liability company (the “LLC”) were owned by a partnership. A trust that owned more than 50 percent of the ownership interests in the partnership transferred those interests in a transaction that did not result in a termination of the partnership for federal income tax purposes. Nonetheless, the transfer constituted a change in ownership of the Los Angeles County real property, which triggered a revaluation of the property for property tax purposes. Los Angeles County also took the position that the change in ownership in the partnership interests also constituted a change in ownership of the real property for documentary stamp tax purposes, and assessed tax against the LLC. The LLC paid the tax and filed a refund action in the Superior Court of Los Angeles County. The Superior Court denied the refund and, in 2014, the Court of Appeal affirmed.
Some California cities and counties have already begun to impose the documentary transfer tax in connection with the transfer of ownership interests in a legal entity that result in a transfer of beneficial interest in real property. However, most cities and counties have been reluctant to do so. This decision will surely expand the ranks of cities and counties applying the documentary transfer tax to transfers of ownership interests in legal entities. Business entities engaged in mergers, acquisitions and restructuring transactions should review their transactions carefully to determine whether the transactions will trigger a documentary transfer tax obligation for any California real property owned by the entities.