Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.
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M A R K E T H I G H L I G H T: S E AT T L E 18 • November 2015 • Western Real Estate Business www.REBusinessOnline.com SEIZE TAX OPPORTUNITIES WHEN THE PRICE IS RIGHT Washington State's real estate excise tax can produce a savings or tax trap, depending upon how savvy the investor is. By Norman J. Bruns, Esq. and Michelle DeLappe, Esq. Seattle's hot real estate market pres- ents two special tax-saving opportu- nities — or, for the unwary, two tax traps — involving Washington State's real estate excise tax. The frst arises when above-market rents in place at a property contribute to its selling price. The second occurs with the sale of a property experienc- ing high vacancy. In both scenarios, some buyers and sellers report prices that are higher than they should be for the real estate excise tax. At nearly 1.8 percent of the property's sale price, real estate excise tax is a sizable trans- action cost that deserves attention. Skewed by High Rents With above-market rents, a portion of the sale price may refect the value of contracts and business eforts. The tax only applies to the consideration paid for real estate, so the consider- ation paid for above-market contracts should be separated out as nontax- able. Although we believe Washington law is clear on this, the Department of Revenue has been struggling to de- termine its position. The Department recently agreed that taxable value excludes the portion of the purchase price attributable to above-market rents, but then it changed its position. Since these vacillations occur in the context of individual taxpayers' cases, other taxpayers do not necessarily know what the Department's position is at any given time. The Department has not published any rules or guid- ance specifc to this scenario. Impaired by Vacancy In the scenario involving the sale of a property with high vacancy, the buyer and seller frequently agree on a price as though occupancy were full and then deduct an amount for the va- cancy shortfall. The deduction refects the costs to lease the remaining space, and also the entrepreneurial proft the buyer requires for undertaking the risk and work required to achieve full occupancy. Some parties to a transaction mis- takenly report the stabilized value instead of the amount actually paid for the property. The only price they should report for tax purposes is the sum after deducting for vacancy because that represents the actual amount paid. Both parties have an incentive to ascertain and report the correct price on the real estate excise tax afdavit. Though the parties can negotiate who pays the tax, the seller is responsible for its payment by law. And yet, the Department of Revenue can enforce payment by placing a lien against the property, making the buyer indirectly liable. And both buyer and seller sign the afdavit reporting the sales price, un- der penalty of perjury. Buyers may feel the ongoing efect of the reported price in the form of property taxes, since county assessors pay attention to the afdavits in determining prop- erty tax values. So both parties should care about correctly reporting the transaction. Buyers and sellers in either scenario can put themselves in a favorable tax position by presenting the informa- tion about the transaction carefully, whether in the afdavit or in a refund petition to the Department of Rev- enue. Note that a refund petition, if applicable, must be fled within four years of the transaction date. Information about the transaction should be presented to the taxing au- thorities in a clear manner to establish the correct facts and legal analysis. In the frst scenario, a detailed explana- tion of the facts ideally includes an ap- praisal that excludes the price paid for the value of the above-market leases in place, as opposed to the real prop- erty. In reviewing the transaction, the De- partment of Revenue should presume the price paid is taxable, but the tax- payer can rebut that position. When the transaction price refects more than the price for real estate alone, the Department often next turns to the property's assessed value instead. The taxpayer can argue that, by law, an appraisal as of the sale date trumps the assessed value as evidence of the taxable amount. For this reason, an appraisal is important for the above- market-rent scenario. In the high-vacancy scenario, how- ever, the presumption applies that the price paid is taxable, and no appraisal should be needed: The parties should report the actual price paid after ac- counting for the vacancy shortfall. Recent experience indicates that the Department of Revenue may choose to challenge an afdavit or deny a re- fund claim that takes the position that the portion of the price attributable to above-market rent is untaxable. That does not mean the Department is right, however, and its vacillations suggest its directors feel uncertain about their position. Taxpayers with strong facts should pursue the issue and work diligently to make a strong case that will help the Department get to the right result. Whether a sale involves the added value of contracts or a deduction for high vacancy, seeking professional advice about how to best report the transaction on the real estate excise tax afdavit, or in a refund petition, can turn the sale into a signifcant tax opportunity. Norman J. Bruns, Esq., and Michelle DeLappe, Esq., Attorneys, Garvey Schubert Barer in Seattle. 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