The shrinking real estate LLC loophole

By R. David Weber, Esq.

It is a common adage that two absolutes in life are death and taxes. In the world of real estate, however, the latter part of this truism has not always held firm. For years, savvy real estate purchasers in Ohio have managed to avoid a costly double-whammy of conveyance fees and higher property taxes resulting from increased tax valuations by using entity acquisitions instead of standard real estate transfers.

Derided for years by officials as the “LLC Loophole,” an entity acquisition structure allows an investor to purchase the controlling interest in an entity (typically the membership units of a limited liability company, or “LLC”) that owns a piece of real estate. The key to an entity acquisition is that purchasing the controlling interest in an entity that owns real estate instead of purchasing the real estate itself does not require the recording of a deed or the filing of a conveyance form with the county. This allows the purchaser to avoid paying the statutory conveyance fee, which, in Hamilton County, presently stands at $4.00 per $1,000 of the purchase price. More importantly, however, the lack of a paper trail for the transaction makes it difficult for the County Auditor to support re-assessing the real estate for its purchased value. Instead, the real estate stays assessed at its pre-sale value, subject to periodic re-appraisal, notwithstanding that the real estate was purchased for an amount in excess of its assessed value. A lower taxable value can equal substantial property tax savings over the course of years.

While entity acquisitions provide a convenient way for real estate investors to save on their property tax bills, local school boards, which rely heavily on property taxes for school district funding, are increasingly challenging this method of tax avoidance.

This scenario recently played out in Columbus City Schools Board of Education v. Franklin County Board of Revision. In Columbus City Schools, a real estate investor paid $35,250,000 to purchase the membership interest of an LLC that owned only one asset: an apartment complex with an assessed value of $16,000,000. Thereafter, the Columbus City Schools Board of Education (the “School Board”) became aware of the transfer through associated public record filings, and filed a complaint with the Franklin County, Ohio Board of Revision (the “BOR”) seeking an increase in the apartment complex’s tax valuation to $34,000,000. The BOR rejected the School Board’s argument, and the School Board appealed to the Ohio Board of Tax Appeals (the “BTA”). The appeal to the BTA opened up a discovery process, whereby the School Board obtained the entity acquisition purchase agreement signed by the parties. Using the entity acquisition purchase agreement and adjusting for certain acquired personal property, the BTA set the final real estate value at $34,458,000.

Thereafter, the purchaser appealed to the Ohio Supreme Court, which ultimately rejected the purchaser’s arguments and affirmed the BTA’s decision of value based upon the purchase agreement. Underpinning the Supreme Court’s decision was the nature of the purchase agreement itself, which, in the words of the Court “identifie[d] itself as a purchase agreement for the real estate at issue” and “[took] on the classic form of a purchase agreement for commercial real estate...” The Court also noted that the purchase agreement contained a section permitting the purchaser to elect to purchase the real estate conventionally or use an entity acquisition structure. Finally, the Court wrote that the acquired entity conducted no business other than owning the apartment complex in question, which generated revenue solely through rental income. Taking all of these factors into account, and distinguishing them from the facts of prior judicial decisions, the Supreme Court held that the BTA’s valuation of the real estate based upon the adjusted contract price was appropriate, even though the transfer was structured as an entity acquisition.

Columbus City Schools is likely to encourage school boards to accelerate the practice of identifying potential entity acquisitions and filing complaints to increase property valuations based upon the purchase price of those acquisitions. Therefore, real estate investors must be aware that an entity acquisition comes with the risk of litigation and may not be an absolute means of avoiding or delaying an increase in real estate taxes as a result of a real estate purchase. As Columbus City Schools demonstrates, an entity purchase agreement, if not precisely structured to manifest an honest intent to transfer an actual business, can become evidence used by a taxing authority to set the property tax value of real estate. Real estate investors considering entity acquisitions for the purpose of shielding bona fide real estate transfers from public disclosure would be wise to exercise caution as the legal landscape continues to evolve.

This article is for general informational purposes only, is not for the purpose of providing legal advice, and does not establish an attorney-client relationship. You should consult with an attorney to obtain advice as to your particular issue or circumstances.

Cors & Bassett is a Goering Center corporate partner, and the Goering Center is sharing this content as part of its monthly newsletter, which features corporate partner articles.