by Adi Rappoport and Daniel J. Glassman
For over half a century, Florida tax practitioners have struggled to answer a relatively simple question. Does the Florida documentary stamp tax on deeds (the deed tax) apply to the conveyance of unencumbered Florida real property from a grantor to a wholly owned entity? Over the years the answer to this question has shifted from “no” to “yes” and back to “no” as Florida courts and the Florida Legislature interpreted and refined the concepts of “purchaser” and “consideration” for purposes of the deed tax.1 The most recent (and presumably final) answer to this question came in 2005, when the Florida Supreme Court held in Crescent Miami Center, LLC v. Florida Department of Revenue, 903 So. 2d 913 (Fla. 2005), that such conveyances are not subject to documentary stamp tax.
The Crescent decision resulted in the proliferation of transaction planning that avoided the imposition of the deed tax and caused a headache for property appraisers attempting to determine the valuation of Florida real property for ad valorem tax purposes.2 In response to the “abuse” of Crescent, the legislature amended §201.02 in 2009 to apply the Florida documentary stamp tax to the sale of ownership interests in an entity that owns Florida real property where such real property was conveyed to the entity within three years of sale.3 In addition, in 2007, the legislature enacted §193.1556 to require notice to property appraisers upon the change of control of certain entities owning Florida real estate. This article discusses these two significant recent developments.
The Florida Documentary Stamp Tax
Florida imposes a documentary stamp tax on transfers of real estate by deed at a rate of $.70 per $100 or part thereof of consideration. The Florida documentary stamp tax statute provides in pertinent part:
On deeds, instruments, or writings whereby any lands, tenements, or other real property, or any interest therein, shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or any other person by his or her direction, on each $100 of the consideration therefor the tax shall be 70 cents. When the full amount of the consideration for the execution, assignment, transfer, or conveyance is not shown in the face of such deed, instrument, document, or writing, the tax shall be at the rate of 70 cents for each $100 or fractional part thereof of the consideration therefor. For purposes of this section, consideration includes, but is not limited to, the money paid or agreed to be paid; the discharge of an obligation; and the amount of any mortgage, purchase money mortgage lien, or other encumbrance, whether or not the underlying indebtedness is assumed. If the consideration paid or given in exchange for real property or any interest therein includes property other than money, it is presumed that the consideration is equal to the fair market value of the real property or interest therein.4
The Crescent Case and Its Aftermath
In Crescent, the Florida Supreme Court addressed the application of the Florida documentary tax to the conveyance of a commercial building located in downtown Miami from a limited partnership to a wholly owned, second-tier subsidiary limited liability company called Crescent Miami Center, LLC (CMC). The stated purpose of the transfer was to segregate the property in order to facilitate future unsecured financing. The deed stated that CMC paid $10 and “other good and valuable consideration” for the property. CMC recorded the deed and paid documentary stamp tax on the full value of the conveyance.
After paying the tax, the transferee filed for a refund of the documentary stamp tax. The Florida Department of Revenue (DOR) denied the application, and the transferee filed suit in Miami-Dade Circuit Court challenging the DOR’s refund denial. Both parties moved for summary judgment in the circuit court, and final summary judgment was entered in favor of the DOR. CMC appealed the adverse summary judgment to the Third District Court of Appeal, which affirmed the order of the lower court in favor of the DOR.
The Florida Supreme Court held that the documentary stamp tax did not apply to the conveyance to CMC because the transaction lacked “consideration” and a “purchaser” as required by the statute. According to the court, there was no consideration or purchaser with respect to the transfer of the property to CMC, since “nothing was exchanged by CMC for the grant of property from [the transferor]; [and] thus, there was no consideration or purchaser in the transaction, just a ‘mere change in form of the stockholder’s equity in the corporation.’”5 Furthermore, the court stated “[t]he argument that the increase in the value of [the transferor’s] interest in CMC constituted consideration is not persuasive, as this increased interest resulted from the transfer and was not the consideration for making the transfer.”6 The Florida Supreme Court quashed the Third District Court of Appeal’s decision and remanded the case to the district court for further consideration consistent with the Florida Supreme Court’s opinion.7
In the wake of the Crescent decision, which was published during one of the most active real estate markets in Florida’s history, practitioners began structuring sales of Florida real property to avoid the imposition of Florida documentary stamp tax.8 The benefit of this planning approach is illustrated by the following example: Assume seller S and purchaser P have entered into a purchase and sale contract with a purchase price of $5 million in connection with the sale of real estate. Absent any documentary stamp tax planning, the sale of the real estate would generate a documentary stamp tax of $35,000. However, the transaction could alternatively be structured as follows: 1) S contributes the real estate to a wholly owned, special purpose limited liability company formed solely for the transaction, S LLC; 2) S then sells the membership interests in S LLC to P for the $5 million purchase price; 3) P then dissolves S LLC and takes title to the real estate. S and P end up in the same exact place, except that the documentary stamp tax has been avoided. Under Crescent, there was no documentary stamp tax due on steps one or three since each of these transfers is a mere book transaction where beneficial ownership of the property has not changed. Step two would not be subject to the documentary stamp tax because there is no conveyance of real estate, since S is assigning a membership interest in a limited liability company. This example illustrates how the application of Crescent effectively repealed the documentary stamp tax for a significant number of real estate transactions.
An interesting consequence of the Crescent decision is its impact on ad valorem taxes and the ability of property appraisers to determine the value of Florida real estate. Following up on the previous example, in certain instances, there would be no need for P to dissolve S LLC, where the real estate is a commercial property. Thereafter, it is conceivable that in the future P would sell its membership interest in S LLC and that this pattern would continue for all future sales. This makes it difficult for a county property appraiser to determine when the property has been sold.
When real property is sold, the property is typically assessed the following January 1 in part based on the recorded sales price. Otherwise, property must be inspected every five years.9 If a membership interest in a limited liability company is sold instead of the underlying real estate, the property could conceivably escape reassessment for a number of years following the transfer of the membership interest, because a new deed would not be recorded upon such transfer. Additionally, there would be no public record of the consideration for the transfer of the membership interest for the property appraiser to consider in assessing the value of the property.10
The 2009 Documentary Stamp Tax Legislation
In its 2009 amendment to §201.02, the Florida Legislature clearly articulated its disdain for the use of the Crescent decision as a deed tax avoidance device, stating: “The Legislature finds that the Florida Supreme Court opinion in Crescent Miami Center, LLC v. Florida Department of Revenue, 903 So. 2d 913 (Fla. 2005), interprets s. 201.02, Florida Statutes, in a manner that permits tax avoidance inconsistent with the intent of the Legislature at the time the statute was amended in 1990.”11
While the legislature voiced its endorsement of the opinion issued by the Third District Court of Appeal in Crescent, which the legislature stated interpreted §201.02 in a manner that prevented tax avoidance, it also stated that it does not intend to overturn the Florida Supreme Court’s decision in Crescent with respect to the conveyance of unencumbered Florida real property to artificial entities. Instead, it objects to the concept that ownership interests in entities may be conveyed without the imposition of a Florida documentary stamp tax. On this point, the legislature stated:
The Legislature recognizes that the Supreme Court’s opinion in Crescent is limited to the facts of the case and accepts the court’s interpretation of s. 201.02, Florida Statutes, that no consideration exists when owners of real property unencumbered by a mortgage convey an interest in such property to an artificial entity whose ownership is identical to the ownership of the real property before conveyance. The Legislature expressly rejects any application of the court’s interpretation where the facts are not comparable to the facts in Crescent. However, because the Supreme Court’s interpretation, combined with other settled law regarding the application of s. 201.02, Florida Statutes, allows for the tax-free transfer of ownership interests in real property from one owner to another through the use of artificial entities, it is the Legislature’s intent by this act to impose the documentary stamp tax when the beneficial ownership of real property is transferred to a new owner or owners by the use of techniques that apply the Supreme Court’s decision in Crescent in combination with transfers of ownership of, or distributions from, artificial entities.12
The legislature addressed its stated concerns by amending §201.02 to confirm the essence of the Florida Supreme Court’s opinion in Crescent that a conveyance of unencumbered real property to an entity is not subject to documentary stamp tax. However, the subsequent sale of the ownership interest in such entity within three years of the conveyance of the Florida real property would be subject to the documentary stamp tax.
The amendment to the statute accomplishes this result by creating the concept of a “conduit entity,” which is defined as a legal entity to which real property is conveyed without full consideration by a grantor who owns a direct or indirect interest in the entity, or a successor entity.13 The term “full consideration” means the consideration that would be paid in an arm’s length transaction between unrelated parties.14
The amended statute provides that when real property is conveyed to a conduit entity and all or a portion of the grantor’s direct or indirect ownership interest in the conduit entity is subsequently transferred for consideration within three years of such conveyance, then tax is imposed on each such transfer of a conduit entity interest for consideration at the rate of $.70 for each $100 or fraction thereof of the consideration paid or given in exchange for the ownership interest in the conduit entity.15
When an ownership interest is transferred in a conduit entity that owns assets other than the real property conveyed to the conduit entity, the tax is prorated on the percentage the value of such real property represents of the total value of all assets owned by the conduit entity.16
The three-year holding period in many ways diminishes the desirability of structuring a sale of real property through a conduit entity. In acquiring the ownership interests of an entity, the buyer assumes all known and unknown liabilities of the entity. The potential liabilities associated with real property can be significant, including environmental exposure and premises liability. Thus, a potential buyer would be hesitant to acquire interests in an entity that was funded with real estate and has been operating for more than three years. The buyer would typically prefer to acquire the real property outright. The legislature was probably aware of this dynamic in requiring a three-year holding period.
The statute contains three notable exceptions from the application of documentary stamp tax on the conveyance of ownership interests of conduit entities within three years of the conveyance of real property to such entities. First, a gift of an ownership interest in a conduit entity is not subject to tax to the extent that there is no consideration.17 This exception is consistent with the general rule that the documentary stamp tax does not apply to gifts of unencumbered realty.18
Second, the transfer of shares or similar equity interests in a conduit entity which are dealt in or traded on public, regulated security exchanges or markets is not subject to tax.19 This provision apparently contemplates a conveyance of real property to a conduit entity, which becomes a public company within three years of transfer. In such case, the documentary stamp tax would not apply to the grantor’s sale of ownership interests in such public company.
Finally, the amendment to §201.02 provides that a transfer for purposes of estate planning by a natural person of an interest in a conduit entity to an irrevocable grantor trust as described in subpart E of part I of subchapter J of chapter 1 of subtitle A of the United States Internal Revenue Code is not subject to documentary stamp tax.20 There is no requirement that the transfer to such irrevocable grantor trusts be without consideration. Although this has been included to facilitate “estate planning,” it is not entirely clear what this provision accomplishes. As an initial matter, it is difficult to properly define “a transfer for purposes of estate planning,” as estate planning itself is an extremely broad concept. In addition, the statute borrows the federal income tax concept of “grantor trusts” to define a nontaxable transfer. Grantor trusts tax the grantor on trust income as though the grantor had retained the property instead of creating the trust. Under the grantor trust provisions, a grantor is taxed on trust income if the grantor retains a reversionary interest whose value is initially greater than five percent of the value of the trust or specified rights to control beneficial enjoyment of the corpus or income or if the grantor retains or vests in a nonadverse party certain administrative powers.
Irrevocable grantor trusts are frequently used in estate planning to create a vehicle that holds assets that are not included in the grantor’s estate for estate tax purposes, but treated as owned by the grantor for income tax purposes. Estate planners often refer to these irrevocable grantor trusts as “intentionally defective grantor trusts.”
The grantor either gratuitously transfers assets to such trusts or sells assets to such trusts. Generally, the grantor will either make an outright gift to such trust or make a small “seed” gift to the trust followed by a larger sale. Because there is a separate exception for gifts, the “estate planning” exception in the amendment likely refers to a sale to an irrevocable grantor trust that completes the transfer for estate tax purposes, but which is ignored for income tax purposes by application of the grantor trust rules. Thus, the provision excludes from documentary stamp tax a transaction that for state law purposes is a sale for consideration, but which is ignored under a fiction created by federal tax law.
Another provision in the legislation addresses trust conversions and mergers. Section 212.02(c) provides that the conversion or merger of a trust that is not a legal entity that owns real property in Florida into a legal entity is treated as a conveyance of real property. The treatment of a merger or conversion as a conveyance potentially accomplishes two goals. First, it maintains the integrity of the three-year period during which the documentary stamp tax applies to the sale of conduit entities. A taxpayer cannot avoid the result by conveying Florida real property to a trust, which then converts or merges into a Florida entity. The conveyance or merger would start the three-year clock running. Secondly, this provision likely eliminates the ability to avoid documentary stamp tax by conveying Florida real property to an out-of-state business trust, which then merges into a Florida entity.
The 2007 Notice of Change of Control Legislation
In 2007, the Florida Legislature enacted §193.1556, which requires any person or entity that owns nonhomestead real property to promptly notify the property appraiser of any change of ownership or control. A change of ownership or control generally means any sale, foreclosure, transfer of legal title or beneficial title in equity to any person, or the cumulative transfer of control or of more than 50 percent of the ownership of the legal entity that owned the property when it was most recently assessed at just value.21 The change of ownership is reported on Form DR-430, Notice of Change of Ownership or Control Non-Homestead Property, by the owner to the property appraiser in the county where the property is located.
The failure to provide the required disclosure results in the ability of the property appraiser to determine for a period of 10 years that the assessed value of the property should have been higher as a result of the change in control transaction. In addition to the payment of any increase in taxes during such 10-year period, the property owner would be required to pay interest at a 15 percent annual rate on such increase in taxes and a penalty of 50 percent of such increase in taxes.22
The notification requirement provides the property appraiser with information concerning the sale of real property through entities so that a property’s assessed value for property tax purposes are determined by taking into account recent transactions that change beneficial ownership. It resolves the quandary created for property appraisers where the transfer of real property is accomplished through the sale of an ownership interest in an entity.
The 2007 and 2009 statutory revisions described in this article create new requirements and issues for Florida practitioners that deal with the conveyance of Florida real estate. The purchase and sale of ownership interests in an entity that owns Florida real estate may result in the imposition of deed tax and change of control disclosure obligations. Therefore, the payment of the deed tax and the change of control disclosure should be addressed in due diligence checklists and in purchase and sale agreements, so that these items do not slip through the cracks when Florida real property is directly or indirectly conveyed as part of a transaction.
1 Bernard A. Barton, Jr., David P. Burke & Mitchell I. Horowitz, Kuro and Muben-Lamar in the Eye of the Beholder? 76 Fla. B. J. at 42 (May 2002).
2 Stephen G. Vogelsang and Adi Rappoport, Crescent — Did the Florida Supreme Court Effectively Repeal the Documentary Stamp Tax on Transfers of Real Estate? 79 Fla. B. J. 44 (Oct. 2005).
3 2009 Fla. Laws Ch. 2009-131, §4. The law is effective where the first transfer to a “conduit entity” occurred after July 1, 2009.
4 Fla. Stat. §201.02(1)(a) (2010).
5 Crescent, 903 So. 2d at 918-919.
6 Id. at 919.
8 Jeff Ostrowski, Critics Push to Plug Hole in Tax Loophole, Palm Beach Post, August 12, 2007.
9 Fla. Stat. §193.023(2) (2010).
10 The Florida Legislature’s response is discussed later in this article.
11 2009 Fla. Laws Ch. 2009-131, §3(1).
12 2009 Fla. Laws Ch. 2009-131, §3(3).
13 Fla. Stat. §201.02(b)1.a (2010).
14 Fla. Stat. §201.02(b)1.b (2010).
15 Fla. Stat. §201.02(b)2 (2010).
16 Fla. Stat. §201.02(b)3 (2010).
17 Fla. Stat. §201.02(b)4 (2010).
18 Fla. Admin. Code R. 12B-4.014(2)(a) (2009).
19 Fla. Stat. §201.02(b)4 (2010).
20 Fla. Stat. §201.02(b)5.
21 Fla. Stat. §193.1554 (2010).
22 Fla. Stat. §193.1556 (2010).
Adi Rappoport is a shareholder of Gunster, Yoakley & Stewart, P.A., residing in the firm’s West Palm Beach office. He is board certified by The Florida Bar in taxation. He earned his B.S. in accounting, J.D., and LL.M. in taxation at the University of Florida.
Daniel J. Glassman is an associate in the Tax Practice Group at Gunster, Yoakley & Stewart, P.A. He received his J.D., summa cum laude, in 2006 and his LL.M. in taxation in 2008, both from the University of Florida College of Law.
This column is submitted on behalf of the Tax Section, Guy E. Whitesman, chair, and Michael D. Miller and Benjamin Jablow, editors.