News

As everyone will agree, the 2006 New Jersey legislative session produced sweeping and controversial changes to New Jersey’s realty transfer fee. Most notable was the expanded application of the grantee-imposed one percent “mansion tax” to specific income-producing commercial property transfers involving deed and “controlling interest” transfers. Such changes went into effect for transfers occurring on or after August 1, 2006.

However, another highly significant change to the New Jersey realty transfer fee was subsequently enacted, with relatively little media attention and taxpayer awareness.

Effective September 5, 2006, New Jersey effectively “reactivated” their realty transfer fee rules, which had expired July 21, 2003. These rules are essentially regulations in that they represent the interpretation of existing law. The newly reactivated rules, although substantially similar to the expired rules, contain a new, significant provision that targets transfers between entities with “common ownership.”

Specifically, N.J.A.C. 18:16-6.1 provides that “a deed transferring real property from one legal entity to another legal entity that has “common ownership” is subject to the realty transfer fee, and the taxable consideration includes the monetary value of stock transferred or contribution to capital by the grantor.” It further provides that “when a value is indeterminable, the realty transfer fee is calculated on the assessed value of the property being conveyed on the date of the transfer adjusted to reflect the true value as determined by the Director’s Ratio established for that municipality for the current year.”

What’s disturbing about this new provision is that it represents a significant deviation from the current practice involving the transfer of unencumbered real property to an affiliated entity for no cash consideration. It has been the widespread understanding among practitioners and the real estate community alike that such transfers should not result in a New Jersey transfer fee consequence since they are completely without consideration. Support for this treatment stems from an interpretation of another specific provision contained in the newly activated rules, that was also contained in the previously expired rules.

This provision, N.J.A.C. 18:16-4.3, states that in the case of a deed conveying real property which is subject to a mortgage, the consideration base upon which the realty transfer fee is computed includes, in addition to any cash consideration, the unpaid balance on any mortgage to which the property is subject and any other lien or encumbrance not paid, satisfied or removed in connection with the transfer. A reasonable interpretation of N.J.A.C. 18:16-4.3 is that a transfer of unencumbered real property without any cash consideration paid in connection with the transfer would result in zero consideration with respect to such transfer for purposes of the New Jersey realty transfer fee. This is also consistent with the definition of “consideration” contained within such rules.

However, the new N.J.A.C. 18:16-6.1 appears to be in direct contradiction to N.J.A.C. 18:16-4.3. This is based largely on the fact that from an intuitive perspective, the predominance of transactions involving transfers of unencumbered property with no other cash consideration occurs between affiliated entities. This contradiction leaves taxpayers and practitioners in a quandary as to which provision is applicable to a particular transaction. Two major contributing factors to this issue is the fact that the term “common ownership” contained in the new provision is not defined anywhere in the newly enacted New Jersey rules, and the overall definition of “consideration” contained in the new rules makes no reference to the use of a property’s assessed value other than in the case of a leasehold interest.

Through several informal discussions with representatives of the New Jersey Division of Taxation (the “Division”), it was indicated that the Division intends to apply the new “common ownership” transfer provision on a retroactive basis, meaning that it is applicable to all open tax years. For previously filed returns, the statute of limitations is four years from the date such return was filed, and thus are open for assessment until such period expires. The Division is taking this position based on their contention that the new “common ownership” rule merely formalizes the Department’s longstanding policy that such transfers have been subject to tax based on the real property’s assessed value. Many practitioners can say that having worked extensively with the New Jersey transfer fee for many years, such policy has not been communicated by the Division. This author is also not aware of any previous challenge by the Division of a “zero consideration” filing involving the transfer to affiliated entities.

It remains to be seen how this will all play out in the long run, as there are currently many unresolved issues, coupled with seemingly conflicting provisions. In the meantime, taxpayers and practitioners still facing the impact of the new “mansion tax” and “controlling interest” legislation, must also address weigh the implications of the new “common ownership” rules on past, pending and future transactions.

James E. Helmus is Executive Director of State and Local Tax Services at The Schonbraun McCann Group, a national real estate and finance consulting firm with offices in New York, New Jersey and Florida. Helmus can be reached at jhelmus@smgllp.com or at 973/364-0400.