Partner Buyout with new LLC Multiple Transfer Taxes??

16 Replies

Hi all, I have a situation that I am trying to avoid.  If anyone has ever run into it before or knows how to avoid it your knowledge would be greatly appreciated.

So my father-in -law and his former business partner have a property valued at $3,000,000. We are buying out the former partner. Originally they had the property in a partnership agreement. The lender is requiring a single entity to refinance the property with and their current partnership has multiple properties so I can't just buy out the half of the partnership. (I will be buying out the other property as well but that will be a different transaction.) We also want to use an LLC for the added protection.

So here is the problem we are running into, we are being told that there will be two transfer taxes when the sale occurs. One for the transfer of the former business partners ownership to the LLC and one for my father-in-law to the LLC. I understand this is two separate people being transferred into the LLC but it is a single transaction. Anyone know of a way to have it be a single transfer tax? This is going to be an extra $30,000 hit.

The way we have the sales agreement is only between the former business partner and the LLC which is why they are saying it's going to be two transfer taxes. If we put the sales agreement between both the former business partner and my father-in-law to sell to the LLC it will be a single transfer tax. However, in that case my father-in-law will have to pay capital gains because he will actually be selling to the LLC and not just transferring his ownership. That would cost him $200,000. We are not looking to do that!

  

@David Walkotten   I hadn't considered the Quitclaim deed.  However, I think it still counts as a transfer in PA.  I will have to look into it.  Thanks for the idea Dave.  

If anyone else has any other ideas that would be great.  Thanks again!

@Michael Badin

Make the sale from the partnership to the LLC. Father-in-law's the only one in the LLC or others can be in the LLC -doesn't really matter. One sale one tax. Get an attorney and or title company in your state to help you make sure it happens as one sale. If the properties are in Pennsylvania PM me and I can give you some names

@Carl Fischer The problem with doing it that way is then my father-in-law is actually selling his interest in the property to the LLC and not just transferring it. He would then have to pay his capital gains tax which would cost his $200,000.

If he transfers his interest he does not have to pay the capital gains yet.

The PA Department of Revenue transfer tax forms allow transfer of partial interest in the property; maybe you should look at each transfer as only a partial so that only a part of the transfer tax is due upon each transfer.

You need a true commercial real estate attorney who knows PA, not a residential attorney who’s done a few small commercial deals. Spend a few dollars with the right attorney and sounds like you might save multiples. I can provide a referral from my professional full-time work experience if you’re interested.

@Steve Babiak Yea, actually I believe that is how it is being viewed.  The property is worth $3,000,000.  Half obviously is 1.5.  As I understand it transfer tax is 1% for the seller and 1% for the buyer.  So on 1.5 each 1% transfer tax would be $15,000.  So to transfer the prior partners share would be 2% total or $30,000 and to transfer my father-in-laws portion would be another 2%, another $30,000.  

We are going to end up being responsible for a total of 3% = $45,000 (as we will be the transferee and buyer) and the prior partner 1% = $15,000 (just the seller)

@Brian Primost    sure that would be great.

There are a couple of additional things to point out.

Transfer tax percentage is not uniform throughout the state of PA; the state portion is 1%, then the school district and county can set some percentage that is in addition to the state's share - most localities have an extra 1% to total to the 2% mentioned in another post, but places like Reading, Phikadelphia and Scranton for example have a much higher total (at least double the 2%). So location matters.

Then there is the 89-11 approach to transfers that is better explained in the link below:

https://www.drinkerbiddle.com/insights/publication...

Maybe @Chris K. or @David Krulac might have some other ideas.

@Michael Badin , @David Walkotten @Steve Babiak

Quit Claim Deed still incurs PA Transfer Tax.

AS Steve said most of PA the total transfer Tax is 2%, but besides the places Steve mentioned, I think Pittsburgh also charges more than 2%.

We have transferred property from (in PA) from an LLC to an individual who was a owner/partner in the LLC. In that case the 50% partner only paid Transfer Tax on the 50% that they did not already own; therefore for property in most of the PA state would be 2% times the value of $1,500,000. If the property is in a higher transfer tax area it would be more.

By custom in PA. the buyer pays half and the seller pays half, but that is NOT a law or a requirement.  The taxing bodies, state, municipality and school district do NOT care who pays it only that it gets paid.

If your father is actually paying less than $1,500,000 for the share that he doesn't already own, then the transfer tax should be on the LESSER amount.  If your father is paying LESS than the assessed value times the common level ratio, then he may (actually will) hear from the Department of Revenue questioning an under payment of the transfer tax.

By my thinking, your father should only be paying 2% of $1,500,000  or $30,000.  So I just saved you $30,000, I'll expect the commission check in the mail, or you can pay me at DIG on Wednesday. (just kidding)

@Steve Babiak    Thanks for the info.  

@Brian Primost Thanks for the names.

@David Krulac

Seems to be a slightly different situation. If I was understanding you correctly you were doing a single transfer from an LLC to an individual.

So we are purchasing the prior business partners half of the property.  That half of the property is valued at 1.5m.  We will pay 1% transfer tax on that purchase and the former partner will pay 1% transfer tax.  (This has already been agreed upon.)  

However our mortgage company that we are using is requiring that we use a single entity to purchase the property. In order to do so my father-in-law then needs to transfer his half (also valued at 1.5m) into the LLC that we are forming and using to purchase the former partners half of the business. On that transfer we are the transferor (my father-in-law) and the "transferee" (the LLC). On that transaction we will need to pay the full 2% transfer tax. Adding both transactions together we would be responsible for 3% or $45,000.

Unfortunately the more I research the less hopeful I am that I will be able to avoid this.  

@David Krulac   I agree that it should be and wish you were right but the way the tax law is written it does not appear to be the case...  however

@Steve Babiak   Thanks for the link!  I looked it over and it does appear there might be a way to be creative and work around it.  Don't know yet if it will work but I am again hopeful.  Thanks!

@Michael Badin

Depending on the level of patience that all the parties have (including your lender and former partner), you guys might be able to avoid it as a conversion. But it's hard to say without taking a look at all the facts. It's also one of the most litigated and confusing issues when it comes to realty transfer tax since there's some level of politics involved (i.e. the interpretation of the PA Department of Revenue under a Democratic Party regime will not always match the interpretation under a Republican Party regime).  

On a related note, I'm not sure what kind of business you are buying. But assuming it's not just a real-estate holding company, you may want to structure it so that you have two different LLCs. One is for the actual business and the other is as a real-estate holding company. Depending on how you structure that, you might be able to save some money. 

If you haven't already, I would strongly advise that you work with a lawyer/law firm that specializes in realty transfer tax. I can put you in touch with experts if you wish --- just PM me. I've done my share of it but realty transfer tax laws are rather volatile and fact specific. For complicated situations like this, it's something lawyers really need to sit down and think about as a group to get the correct answer. 

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

@David Walkotten   @Carl Fischer   @Steve Babiak   @Brian Primost   @David Krulac   @Chris K.

UPDATED:

Hi all it’s now been about two months and I wanted to provide an update on the outcome of my situation. I also wanted to thank everyone that responded and provided guidance. This community and the support it provides is amazing!

So we finally closed. Ended up having to delay two months to get everything sorted out but it’s finally done. Needed the help of a good real estate attorney and thank you to everyone who made a recommendation. I received many recommendations both through biggerpockets and elsewhere. (Too many to contact everyone, so if I did not contact your recommendation I am sorry but I still greatly appreciate your guidance.)

We were able to transfer my father-in-law's portion of ownership of the property without a second transfer tax by using a Trust instead of using an LLC. Another benefit of using the Trust is that we retain the "step-up" basis whereas if we had used the LLC the capital gains tax liability would have transferred from my father-in-law to the LLC.

The added cost from the attorney and the rate change (minimal) from the delay was still more than $10,000 less than the transfer fee would have been.  Plus, the savings of the future capital gains (Which would have cost me six figures in the future based on what my father-in-law acquired the property for vs current value) greatly outweighs the loss of the two months rental income I would have received had we closed two months ago.

Again, thank you to everyone for your assistance. (Especially @Steve Babiak who put me on the trail of the Trust.)