Posted In: Real Estate & Construction
RE&C In Review: Ohio Supreme Court Finds that Purchase Price in "Drop and Swap" Transactions May Establish Tax Value of Real Estate
By Thomas A. Gattozzi & Hanne-Lore M. Gambrell on February 16, 2021
When parties desire to buy and sell real estate, they sometimes will utilize what is known as a “drop and swap” transaction. In a “drop and swap” transaction, the seller of real estate forms a single member limited liability company (LLC), contributes the real estate into the LLC by way of a deed, and then sells the membership interests of the LLC to the buyer. Since there is no deed from the seller to the buyer, the purchase price is not reported in the County records. As such, historically, the purchase price paid in such a transaction has not been relied upon as the best evidence of the real estate’s value for real estate tax purposes since the transaction is for the sale of the ownership interests of the entity, and not the real estate itself.
However, this structure may no longer be a viable method of avoiding an increase in the tax valuation of real estate in Ohio. The Ohio Supreme Court issued a decision on February 6, 2020 finding that the sale price of membership interests in a LLC may be used as evidence of the actual value of the real estate for purposes of taxation.
In Columbus City Schools Board of Education. v. Franklin County Board of Revision, 159 Ohio St. 3d 283, the owner of real property consisting of an apartment complex (further referenced as “the Property”) contributed the Property to a “Drop Down LLC” and then conveyed the membership interests in the Drop Down LLC to the buyer. The Property was originally valued at $16,000,000. The purchase price for the membership interests in the Drop Down LLC was $35,250,000. The Columbus City Schools Board of Education argued for an increase in the valuation of the Property for tax purposes based on the membership interest purchase price. The Franklin County Board of Tax Appeals (BTA) agreed and found that the membership interest transaction reflected the intent of the parties to engage in a real estate transaction. After deducting an amount to reflect the value of personal property involved in the transaction, the BTA relied on the purchase price for the membership interests to arrive at a real estate tax value of $34,458,000 for the Property. The Ohio Supreme Court affirmed the BTA’s decision. The Court noted that the contract and other documentation involved in the transaction reflected the intent of the parties to sell and purchase an income-producing property “and that the parties’ transfer of the corporate ownership constituted a contrivance for accomplishing the sale of commercial real estate.”
The implication of this Ohio Supreme Court decision is to render “drop and swap” transactions as an ineffective method to avoid an increase in real estate tax valuations. School boards are actively filing complaints with boards of revisions to seek increases in real estate tax valuations whenever the public records reflect the recording of a deed transferring real estate to an LLC with an accompanying exemption from conveyance fees. If a transaction involving the sale of LLC membership interests is a disguised real estate transaction, the purchase price in such a transaction most likely will be deemed to be the best evidence of the true value of the real estate. However, if in fact the transaction truly is a sale of the going concern of a business which includes real estate, it is critical that the parties clearly articulate such an intent in the documentation so that there is no question as to the valuation of the real estate.
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