The broadly written provision applies to “C corporations” as well as pass-through entities.
Nonresidents of New York are subject to personal income tax on items of income derived from or connected with New York sources. This includes items attributable to the ownership of any interest in real property in New York. The recently passed New York State budget amended the Tax Law by expanding the definition of real property located in New York for this purpose to include an interest in “a partnership, limited liability corporation, S corporation, or non-publicly traded C corporation with one hundred or fewer shareholders . . . that owns real property that is located in New York and has a fair market value that equals or exceeds fifty percent of all the assets of the entity on the date of sale or exchange of the taxpayer’s interest in the entity.” In making this calculation, the statute includes in the denominator of the fraction “[o]nly those assets that the entity owned for at least two years”. (New York Tax Law § 631(b)(1)(A).)
Although intended to prevent nonresidents from avoiding tax by placing New York real estate in flow-through entities, the statute is not so limited. Tax will also apply to arrangements not structured for any tax avoidance purpose.
Exclusion of Assets Owned for Less than Two Years May Extend the Reach of the Statute
The new statutory provision raises various interpretative questions such as the meaning of “publicly traded” and how the two-year period should be calculated where entities are merged or incorporated or liquidated. The rule is not limited to assets acquired from related persons or assets acquired with a carryover tax basis. It is also unclear how the two-year rule applies to classes of assets which are turned over in the ordinary course of business. For example, an entity with inventories or that replaces its delivery trucks every 18 months ought to be able to include those assets in the calculation even though a particular asset was held for less than two years. This result is by no means certain, however.
Two-Year Rule Also Applies to Allocation Calculation
The selling nonresident’s gain or loss will be allocated to New York under the statute by multiplying the total gain or loss recognized for federal income tax purposes by a fraction, the numerator of which is the fair market value of the New York real estate and the denominator of which is the fair market value of all the assets owned by the entity on the date of the sale or exchange. This formula appears to produce surprising consequences in some circumstances. For example, if an entity owned New York real estate that constituted half of its assets but was not appreciated in value, and the entity also owned for less than two years other assets on which there were large unrealized gains, 100 percent of the taxpayer’s gain on sale of an interest in the entity would be allocated to New York even though all of the gain was economically attributable to assets other than New York real estate. In some circumstances this result might be subject to challenge. (See Matter of British Land (Maryland), Inc. v. Tax Appeals Tribunal, 85 N.Y.2d 139 (1995).)
The new law will apply to sales or exchanges of entity interests that occur 30 or more days after the bill is signed by Governor Paterson. Nonresidents of New York who are contemplating sales that may be subject to this provision may wish to consider adjusting their plans, perhaps by accelerating the closing of the transaction to a time prior to the effective date.