Transfers of Interests in Entities Owning Real Estate: Is Real Estate Excise Tax Due?

In Washington, when title to real estate is transferred from one owner to another, Real Estate Excise Tax, or REET, is generally payable to the State at the time of the transaction.

For the purpose of attempting to limit liability, it is often recommended that investors hold title to real estate in a separate legal entity, such as a limited liability company. And, when title to real estate is held in such an entity, it is often the case that members wish to transfer membership interests between themselves, or to third parties.

The applicable excise tax rules state that transfer of a “controlling interest” in an entity which owns real estate will be subject to collection of REET by the State. In general terms “Controlling interest” means 50% or more of the ownership interests of the entity.

Upon the transfer of a controlling interest, REET is due on the full “true and fair” value of the real estate owned by the entity, not just the proportionate value represented by the interest transferred. Under the rules, if the true and fair value of the real estate cannot be reasonably determined, the value as assessed by the county may be used as the selling price.

There is a further condition to the obligation to pay REET on sale of the controlling interest: the transfer of the controlling interest must take place within a “twelve month period”, which can span two years.

Example 1: Imagine an entity, XYZ LLC, which owns real estate, where A and B are equal 50% owners of the entity. Any contemporaneous transfer of either of their 50% interests to each other, or to a third party, would give rise to assessment and collection of REET by the state.

Example 2: A, B, and C each own 33.33% of XYZ LLC. A could acquire the 1/3 interest of B without REET payable, as it would not be a controlling interest. And, if the parties then let more than a year go by, A could then obtain the 1/3 interest of C as well without REET payable, as the transfer of the controlling interest (the combined 66.66%) would not be within a twelve month period.

A common practice formerly employed with regard to facts similar to example 1 was that less than 50% of the member’s interest (say 49%) would be acquired, and the seller would grant an option to the buyer to purchase the remaining 1% after the expiration of one year. This “loophole” has been closed by the legislature, however, with a provision to the effect that the date the option to purchase a membership interest is signed is now deemed to be the effective date of the transfer.

There are many rules and exceptions applicable to payment of REET on real estate transfers. It is always prudent to contact your attorney to review your particular facts.