Transfer Taxes

When negotiating the distribution of marital property, tax consequences must always be taken into account. There are federal, state and local taxes to consider. Leaving any of these out of the equation, particularly when the divorcing couple is wealthy, can mean that assets from which the parties might have benefited are lost to the tax man.

A Hypothetical

Let us look at one hypothetical involving a couple residing in New York State. The married parties, Henry and Willa, own a townhouse in Manhattan (the Townhouse). They also each own a 50% membership interest in H & W, LLC (the Company), which owns a residence in Amagansett, NY. Neither property is subject to any mortgage.

In May 2013, Henry and Willa engaged a neutral arbitrator/mediator to bring about their mutual agreement on the terms of their separation and divorce. Henry and Willa then proposed that Henry transfer his interest in the Townhouse to Willa prior to their execution of a separation agreement. In turn, she would transfer her membership interest in the Company to him prior to execution of such agreement. Accordingly, following these two transfers, Willa would own the Townhouse and Henry would own all the interest in the Company and thus would own the Amagansett house.

The questions posed by this scenario are: 1) Would these transfers be subject to New York State, New York City and Peconic Bay Region transfer taxes? and 2) Is the tax treatment of the transfer of the beneficial ownership in the Amagansett residence affected by the fact that the property is owned by the Company rather than Henry and Willa directly?

When Is an Exchange Taxable?

New York State imposes a real estate transfer tax (the RETT) on each conveyance of real property or interest therein when the consideration exceeds $500. New York Tax Law ' 1402(a). The RETT is generally imposed at the rate of two dollars for each $500 of consideration (that is, four-tenths of one percent (.4%) of the consideration).

New York State also imposes an additional 1% tax (the so-called Mansion Tax) on each conveyance of residential real property or any interest therein when the consideration for the entire conveyance is $1 million or more. New York Tax Law ' 1402-a. Residential real property includes any premises that are or may be used in whole or in part as a personal residence, including, but not limited to, a one-family house. Id.

Similarly, Article 31-D of the New York Tax Law grants the Town of East Hampton (as well as other towns in the Peconic Bay region) authority to impose a real estate transfer tax on each conveyance of real property or interest therein located in its town. The rate of this tax is 2% of the consideration after subtraction of a $250,000 exemption for improved property ($100,000 for unimproved property (that is, vacant land)). As Amagansett is within the Town of East Hampton, this tax applies to conveyances of real property or interests therein located in Amagansett.

Section 1401(d) of the New York Tax Law defines “consideration” for purposes of the RETT and Mansion Tax in relevant part as:

' the price actually paid or required to be paid for the real property or interest therein, including payment for an option or contract to purchase real property, whether or not expressed in the deed and whether paid or required to be paid by money, property, or any other thing of value. It shall include the cancellation or discharge of an indebtedness or obligation. It shall also include the amount of any mortgage, purchase money mortgage, lien or other encumbrance, whether or not the underlying indebtedness is assumed or taken subject to.

A similar definition applies for purposes of the transfer tax imposed by the Town of East Hampton.

Section 575.9(c)(4) of the regulations issued by the New York State Department of Taxation and Finance and applicable to the RETT and Mansion Tax provide that ” ' conveyances without consideration and otherwise than in connection with a sale, including conveyances by bona fide gift” are exempt from such transfer taxes. 20 NYCRR ' 575.9(c)(4).

On the other hand, Section 575.11(a)(1) of such regulations provides that: “A conveyance in exchange for other property is taxable. If the other property is real property or an interest therein, the tax will apply to both conveyances.” Again, the Town of East Hampton has adopted similar regulations applicable to its transfer tax.

'Bona Fide Gift'

The New York State transfer tax regulations do not define the term “bona fide gift.” However, Section 575.9(c)(4), as quoted above, cites a “bona fide gift” as an example of a conveyance without “consideration.” In turn, “consideration” is broadly defined in Section 1401(d) of the Tax Law to include “money, property or any other thing of value.” Thus, for purposes of determining whether a conveyance is a gift for transfer tax purposes, the test would appear to be whether the transferor receives any quid pro quo .

In this regard, the transfer tax cases and rulings often adopt principles from the federal income tax law, under which a payment is considered a gift if it proceeds from a “detached and disinterested generosity” ' out of affection, respect, admiration, charity or like impulses.” Commissioner v. Duberstein, 363 U.S. 278 (1960).

Applying the Law

In our hypothetical, Willa's transfer of her interest in the Company to Henry does not appear to proceed from “detached and disinterested generosity.” Rather, Henry's transfer of his interest in the Townhouse to her is the quid pro quo for her transfer of her interest in the Company to him. Consequently, if all the facts are considered, it is not possible to characterize her transfer to him as a “bona fide gift” that is exempt from transfer tax. Instead, her transfer of her interest in the Company to him constitutes an exchange. The consideration she receives from him for her transfer is his interest in the Townhouse. The New York State RETT payable with respect to her transfer, as well as the Mansion Tax and Peconic Bay transfer tax, will be based on the value of the interest she receives from him.

(For purposes of this article, we leave aside the question of whether the tax should be measured by the fair market value of her 50% interest in the Company, rather than his 50% interest in the Townhouse, in a case in which the value of the two interests were not equal.)

Of course, under this analysis, Henry's transfer of his interest in the Townhouse to Willa will also be subject to New York State RETT and the Mansion tax. In addition, his transfer will be subject to the New York City Real Property Transfer Tax (the RPT). (The New York City RPT is generally imposed on a deed at the time of delivery by a grantor to a grantee when the “consideration” for the real property exceeds $25,000. New York City Administrative Code ' 11-2102.a. For this purpose, “consideration” is defined in a manner virtually identical to the manner in which the term is defined in Section 1401(d) of the New York State Tax Law for purposes of the RETT. See New York City Administrative Code ' 11-2101(9).)

Similarly, in a rule virtually identical to Section 575.9(c)(4) of the New York State tax regulations, the Department of Finance has adopted a regulation excluding from the RPT as a transfer without consideration, a transfer that constitutes a “bona fide gift.” 19 RCNY Rule Section 23-03(j)(1).) See, e.g., Matter of Jungil Song, TAT (E) 06-12 (RP) (New York City Tax Appeals Tribunal, Sept. 29, 2008) (wife's recent execution of a guarantee of a mortgage on property suggested that the subsequent transfer by husband of an interest in such property to wife was not a gift).

Next month, we will continue our discussion of the tax consequences of our hypothetical couple's marital property transfers.

Elias M. Zuckerman is a partner with Katsky Korins, LLP, where has headed the firm's tax department since 1988. He gratefully acknowledges the research assistance of Daniel Gibralter, an associate in the real estate department of the firm.

When negotiating the distribution of marital property, tax consequences must always be taken into account. There are federal, state and local taxes to consider. Leaving any of these out of the equation, particularly when the divorcing couple is wealthy, can mean that assets from which the parties might have benefited are lost to the tax man.

A Hypothetical

Let us look at one hypothetical involving a couple residing in New York State. The married parties, Henry and Willa, own a townhouse in Manhattan (the Townhouse). They also each own a 50% membership interest in H & W, LLC (the Company), which owns a residence in Amagansett, NY. Neither property is subject to any mortgage.

In May 2013, Henry and Willa engaged a neutral arbitrator/mediator to bring about their mutual agreement on the terms of their separation and divorce. Henry and Willa then proposed that Henry transfer his interest in the Townhouse to Willa prior to their execution of a separation agreement. In turn, she would transfer her membership interest in the Company to him prior to execution of such agreement. Accordingly, following these two transfers, Willa would own the Townhouse and Henry would own all the interest in the Company and thus would own the Amagansett house.

The questions posed by this scenario are: 1) Would these transfers be subject to New York State, New York City and Peconic Bay Region transfer taxes? and 2) Is the tax treatment of the transfer of the beneficial ownership in the Amagansett residence affected by the fact that the property is owned by the Company rather than Henry and Willa directly?

When Is an Exchange Taxable?

New York State imposes a real estate transfer tax (the RETT) on each conveyance of real property or interest therein when the consideration exceeds $500. New York Tax Law ' 1402(a). The RETT is generally imposed at the rate of two dollars for each $500 of consideration (that is, four-tenths of one percent (.4%) of the consideration).

New York State also imposes an additional 1% tax (the so-called Mansion Tax) on each conveyance of residential real property or any interest therein when the consideration for the entire conveyance is $1 million or more. New York Tax Law ' 1402-a. Residential real property includes any premises that are or may be used in whole or in part as a personal residence, including, but not limited to, a one-family house. Id.

Similarly, Article 31-D of the New York Tax Law grants the Town of East Hampton (as well as other towns in the Peconic Bay region) authority to impose a real estate transfer tax on each conveyance of real property or interest therein located in its town. The rate of this tax is 2% of the consideration after subtraction of a $250,000 exemption for improved property ($100,000 for unimproved property (that is, vacant land)). As Amagansett is within the Town of East Hampton, this tax applies to conveyances of real property or interests therein located in Amagansett.

Section 1401(d) of the New York Tax Law defines “consideration” for purposes of the RETT and Mansion Tax in relevant part as:

' the price actually paid or required to be paid for the real property or interest therein, including payment for an option or contract to purchase real property, whether or not expressed in the deed and whether paid or required to be paid by money, property, or any other thing of value. It shall include the cancellation or discharge of an indebtedness or obligation. It shall also include the amount of any mortgage, purchase money mortgage, lien or other encumbrance, whether or not the underlying indebtedness is assumed or taken subject to.

A similar definition applies for purposes of the transfer tax imposed by the Town of East Hampton.

Section 575.9(c)(4) of the regulations issued by the New York State Department of Taxation and Finance and applicable to the RETT and Mansion Tax provide that ” ' conveyances without consideration and otherwise than in connection with a sale, including conveyances by bona fide gift” are exempt from such transfer taxes. 20 NYCRR ' 575.9(c)(4).

On the other hand, Section 575.11(a)(1) of such regulations provides that: “A conveyance in exchange for other property is taxable. If the other property is real property or an interest therein, the tax will apply to both conveyances.” Again, the Town of East Hampton has adopted similar regulations applicable to its transfer tax.

'Bona Fide Gift'

The New York State transfer tax regulations do not define the term “bona fide gift.” However, Section 575.9(c)(4), as quoted above, cites a “bona fide gift” as an example of a conveyance without “consideration.” In turn, “consideration” is broadly defined in Section 1401(d) of the Tax Law to include “money, property or any other thing of value.” Thus, for purposes of determining whether a conveyance is a gift for transfer tax purposes, the test would appear to be whether the transferor receives any quid pro quo .

In this regard, the transfer tax cases and rulings often adopt principles from the federal income tax law, under which a payment is considered a gift if it proceeds from a “detached and disinterested generosity” ' out of affection, respect, admiration, charity or like impulses.” Commissioner v. Duberstein , 363 U.S. 278 (1960).

Applying the Law

In our hypothetical, Willa's transfer of her interest in the Company to Henry does not appear to proceed from “detached and disinterested generosity.” Rather, Henry's transfer of his interest in the Townhouse to her is the quid pro quo for her transfer of her interest in the Company to him. Consequently, if all the facts are considered, it is not possible to characterize her transfer to him as a “bona fide gift” that is exempt from transfer tax. Instead, her transfer of her interest in the Company to him constitutes an exchange. The consideration she receives from him for her transfer is his interest in the Townhouse. The New York State RETT payable with respect to her transfer, as well as the Mansion Tax and Peconic Bay transfer tax, will be based on the value of the interest she receives from him.

(For purposes of this article, we leave aside the question of whether the tax should be measured by the fair market value of her 50% interest in the Company, rather than his 50% interest in the Townhouse, in a case in which the value of the two interests were not equal.)

Of course, under this analysis, Henry's transfer of his interest in the Townhouse to Willa will also be subject to New York State RETT and the Mansion tax. In addition, his transfer will be subject to the New York City Real Property Transfer Tax (the RPT). (The New York City RPT is generally imposed on a deed at the time of delivery by a grantor to a grantee when the “consideration” for the real property exceeds $25,000. New York City Administrative Code ' 11-2102.a. For this purpose, “consideration” is defined in a manner virtually identical to the manner in which the term is defined in Section 1401(d) of the New York State Tax Law for purposes of the RETT. See New York City Administrative Code ' 11-2101(9).)

Similarly, in a rule virtually identical to Section 575.9(c)(4) of the New York State tax regulations, the Department of Finance has adopted a regulation excluding from the RPT as a transfer without consideration, a transfer that constitutes a “bona fide gift.” 19 RCNY Rule Section 23-03(j)(1).) See, e.g., Matter of Jungil Song, TAT (E) 06-12 (RP) (New York City Tax Appeals Tribunal, Sept. 29, 2008) (wife's recent execution of a guarantee of a mortgage on property suggested that the subsequent transfer by husband of an interest in such property to wife was not a gift).

Next month, we will continue our discussion of the tax consequences of our hypothetical couple's marital property transfers.

Elias M. Zuckerman is a partner with Katsky Korins, LLP, where has headed the firm's tax department since 1988. He gratefully acknowledges the research assistance of Daniel Gibralter, an associate in the real estate department of the firm.