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As most lawyers know, the Pennsylvania transfer tax applies to deeds (or comparable documents), but not to agreements of sale or assignments of these agreements. However, recent regulations have targeted even payments made by assignees of agreements of sale. These regulations seem inconsistent with both the Realty Transfer Tax Act and a Pennsylvania Supreme Court decision. Therefore, some analysts think that they will not stand up to court scrutiny. The issue relates to Pennsylvania’s real estate transfer tax on an agreement of sale that is assigned or “flipped” at a profit by the named buyer in the agreement. How does one compute the transfer tax on the deed? Should the taxable price be based on the purchase price in the original agreement of sale, or should it also include payments made by assignees to the assignor? Supreme Court Speaks In Allebach v. Commonwealth, Dep’t of Fin. & Revenue, the Supreme Court of Pennsylvania seemed to settle that issue when it held that the seller did not have to include the assignment payments in the purchase price. In that case, the Allebachs had entered into an agreement to sell a 61-acre tract of undeveloped land for $610,000. Under the agreement, the purchaser, John Ward, agreed to obtain subdivision and other required approvals and permits needed for construction of houses. Ward then assigned his rights under the agreement to another purchaser who agreed to pay $1,643,000 for the tract. After completion of the subdivision and another interim assignment, the ultimate purchaser agreed to buy the property for $3.2 million. The purchaser took a deed from the Allebachs and paid a transfer tax on what was essentially their original purchase price of $610,000. The Supreme Court rejected the Department of Revenue’s argument that the proper purchase price should have been the $3.2 million paid by the ultimate purchaser. It held that the amounts of consideration paid for assignments among the parties should not have been included by the department in re-determining the transfer tax valuation of the conveyance. In reaching its conclusion, the court found that the statute is clear, and if there were any ambiguity, it should be resolved in favor of the taxpayer. It also held that the realty transfer tax should be based only on the value of the deed, the document presented to the recorder. Because an agreement of sale cannot be taxed under the law, the assignment of rights in an agreement cannot be taxed. In that case, the department had maintained that the taxpayer’s argument would open up a tax “loophole.” The court responded that if that is the case, it is up to the Pennsylvania Legislature to deal with that, and it’s not within the scope of the courts to change those laws “simply because we may believe that they do not adequately address the fiscal needs of this commonwealth.” Combining Transactions The Department of Revenue has never been comfortable with this decision and now, in Realty Transfer Tax regulations, effective December 2007, it has attempted to do an end-run around the Supreme Court. The regulations articulate the position that the department will take in enforcing the tax. On this issue, it has decreed that the additional payments made to the assignor must be included in computation of the purchase price. One concession is made to the grantor, who is the original seller under the agreement of sale. That seller will only have to pay the part of the transfer tax that relates to the original price in the agreement of sale. The additional transfer tax based on the enhanced price will have to be paid by the assignee, who becomes the grantee in the deed. RTT Regulation 91.170 includes a section titled “Combining Transactions.” When a single document represents in substance two or more transfers of title to real estate, the document is viewed as a series of separate transfers and documents, and the tax due on the single document is the same as the sum of the tax that would be due had each transfer been effectuated by a document. For example: X agrees to sell real estate to Y for $100,000. Y assigns the agreement of sale to Z for $1 million. X executes the deed conveying the real estate to Z and receives $100,000. Y receives $1 million from Z for the assignment. The taxable value of the deed from X to Z is $1.1 million. X and Y are jointly and severally liable for the tax on $100,000. Y and Z are taxable for the remaining tax on $1 million. That proposition is novel under the regime of real estate transfer taxes. It sets up what might be called a “dual-purchase-price” system where the grantor pays a different transfer tax than the grantee. The rationale behind that seems to be an attempt at fairness among the parties once the department has assigned a tax to the assignment payment. For example, if the Allebachs had to pay an equal share of the increased transfer tax, they would have been liable for a tax on a portion of the purchase price that they never received. In fact, they had received roughly only one-fifth of the total “purchase price that was paid for the property.” Commissions, Fees and Other Issues The regulation raises other issues: • An undeveloped property may increase in value during the developmental stage because of various services performed. For example, in Allebach, one of the assignees went through a process of preparing plans, posting security for planning improvements and hiring experts and attorneys to get through the customary land development, sub-division, zoning and environmental regulations and requirements. The original buyer might view the increased price merely as reimbursement of the time and costs involved in that process. In light of the fact that much of that cost may go to third-party architects, engineers, attorneys and bankers, should that part of the ultimate purchase price properly be considered “consideration” for the deed? • Suppose the developer had accrued all those costs and then simply asked the assignee to pay those third parties when the assignee closed on the deed from the original seller. Will the Department of Revenue take the position that those third-party costs should be added to the purchase price? How about if the assignor only receives a customary brokerage fee of, say, 6 percent for the transfer. Should that be taxed as a “flip price”? What if she performs extraordinary brokerage services and receives a fee of 10 or 20 percent? • The regulation on “combining transactions” to increase transfer taxes attempts to stretch the tax net beyond what appears to be a contrary Supreme Court precedent. As the examples in the regulations show, it could create unexpected tax problems on other types of transactions, such as transferring industrial-development-authority installment contracts. • Let’s test the logic of the department’s novel transfer-tax theory. What happens if the property loses value after the buyer signs the agreement of sale? Unfortunately, we live in a world where the value doesn’t always increase as in the department’s carefully crafted examples. If the original buyer wants to assign the agreement to relieve itself of what has become a liability, it will receive no premium from the assignee. In fact, it may have to pay that assignee to take over the agreement. Does the department’s dual-price system work both ways? That is, will the department then tax the original seller on the price stated in the agreement of sale, and tax the assignee/grantee on the lower price reached by reducing the price in the agreement by the amount that the original buyer had to pay to the assignee? For example, let’s use the department’s “X, Y, Z” format. X agrees to sell the original buyer, Y, a property for $100,000. Y induces Z to take the agreement off Y’s hands by paying Z $10,000. The substance of the transaction is that the property is costing Z a net price of only $90,000. Is Z then taxed only on $90,000? It remains to be seen whether the courts will honor this type of “lawmaking” by the Pennsylvania Department of Revenue. Harris Ominsky is a past president of the Pennsylvania Bar Institute and his most recent book, Real Estate Lore, Modern Techniques and Everyday Tips for the Practitioner, has been published by the American Bar Association.

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