NYC Transfer Tax
According to the New York City Comptroller, the City collected approximately $1.13 billion in Real Property Transfer Tax (“RPTT”) in the FY 2024. The Comptroller’s Office has forecast that $1.21 billion of RPTT will be collected in FY 2025.[i] Impressive figures by most measures, but just a drop in the proverbial bucket compared to the City’s total tax revenue for FY 2024 of almost $75 billion,[ii] and of its estimated tax revenue of more than $77 billion for FY 2025.[iii]
Still, the RPTT is no laughing matter when one considers that the tax is imposed at a rate of 2.625% of the purchase price for the “transfer” of commercial “real property,” or of an “economic interest” in such property,[iv] located within the City, where the value of the property is more than $500,000.[v]
Notwithstanding recent price adjustments, New York City (“NYC”) real estate remains very expensive and, consequently, the RPTT continues to represent a significant additional cost with which the parties to most real estate transactions must contend.
Exempt Transfers
There are certain transactions, however, to which the tax does not apply. For example, the tax is not imposed upon either the purchase or sale of NYC real property, or of an economic interest therein, by “any corporation, or association, or trust, or community chest, fund or foundation, that is organized or operated exclusively for religious, charitable, or educational purposes, or for the prevention of cruelty to children or animals,” provided no part of such net earnings inures to the benefit of any private shareholder or individual, and provided further that the organization does not carry on propaganda or attempt to influence legislation as a substantial part of its activities (an “Exempt Org”).[vi]
Of course, it is a general principle of tax law that any statutory exemption from the imposition of an otherwise applicable tax is a matter of “legislative grace” and should be construed strictly, especially when there is any ambiguity in the statute, in which case any doubt would typically be resolved against the exemption.
Unfortunately, there are instances in which the application of this fundamental principle of statutory interpretation may lead to what some may regard as a ridiculous outcome, as one New York not-for-profit corporation recently experienced.
A Financially Challenged College[vii]
The College was incorporated by the New York Board of Regents for the purpose of “establishing and maintaining an institution of higher education at the collegiate level,” and the IRS recognized its exemption from federal income tax[viii] as an organization described in Section 501(c)(3) of the Code.
The College originally purchased real property in NYC (the “Property”) for the purpose of housing its students and supervising housing staff. When the College began to experience financial difficulties during the pandemic, it obtained a loan that was secured by the Property.[ix] As its financial difficulties continued, the College sought to refinance this loan.
The LLC
In order to refinance the original loan, the new lender (the “Lender”) required the College to transfer the Property to a newly formed limited liability company (the “LLC”) that would be a bankruptcy remote entity[x] with the College as the sole member.[xi]
The College formed the LLC as a single purpose entity to own the Property. In addition, as a condition of the loan, the Lender required that the College draft the LLC’s operating agreement (the “Operating Agreement”) in a manner to protect the Lender from the risk of the LLC being taken into bankruptcy in the event of financial difficulty.
Operating Agreement
Accordingly, the Operating Agreement contained certain provisions that were designed to protect the Lender. It required that the College appoint a director independent from the College, with no ownership interest in the LLC or the Property and no other affiliation with the LLC. The independent director could not be replaced without cause and without at least three business days’ prior notice to the Lender. Such notice was required to include a statement as to the reasons for such removal and the identity of the proposed replacement independent director, with a certification that such replacement satisfied the requirements for an independent director.
At the insistence of the Lender, the Operating Agreement provided that the LLC acknowledged that the Lender was an “intended third-party beneficiary” of the above provisions. Furthermore, the Operating Agreement provided that, without the unanimous consent of the board of directors, including the independent director, the LLC could not file for bankruptcy, liquidate, or take any action that might cause it to become insolvent, admit to an inability to pay debts generally as they became due, or make an assignment for the benefit of creditors generally.
Finally, the Agreement stated that the independent director, while owing a duty to the LLC, did not owe any fiduciary duty to, and was directed not consider the interests of, the LLC’s member – i.e., the College – the other affiliates of the LLC, or any group of affiliates of which the LLC was a part. However, this provision did not supersede the “implied contractual covenant of good faith and fair dealing.”[xii]
Although the rights bestowed upon the independent director provided the Lender the additional measure of security it sought (demanded) with respect to its collateral (the Property), they were inconsequential insofar as the day-to-day functioning of the Property was concerned. The other three directors of the 4-member board (75%) were employees of the College.[xiii] Presumably, that meant that the College controlled the LLC’s board,[xiv] and thereby directed the operation of the LLC and the management of the Property in a manner consistent with the College’s educational mission.
Transfer to the LLC
When the College transferred the Property – subject to the original loan – to the LLC in exchange for all of its membership interests, it filed a Form TP-584-NYC[xv] on which it claimed the transfer was exempt from the RPTT because it effected a mere change of identity, or form of ownership or organization, without changing the beneficial ownership of the Property.[xvi]
When the College filed its IRS Form 990[xvii] for the year of the transfer, it indicated that the LLC was a disregarded entity and was included as a part of the College’s financials.[xviii] In fact, the LLC and the Property were part of the financial structure of the College – the College paid all of the LLC’s expenses, all of the LLC’s revenues were paid directly to the College, the College continued to depreciate the Property on its tax returns, and the College’s employees operated and managed the Property at all times as though the College owned the Property solely for the benefit of the College.
Sale of the Property
The following year, the LLC entered into a contract to sell the Property to the Purchaser.
The College, as the sole member of the LLC, submitted a proposed Petition to the Attorney General of the State of New York (the “Attorney General”) seeking approval to sell the Property.[xix]
The Attorney General required the College to file the Petition with the New York State Supreme Court.[xx] The Attorney General directed the College to seek both (a) retroactive approval of the earlier transfer from the College to the LLC, and (b) approval to sell the Property to the Purchaser. It was the Attorney General’s position that the sale of the Property required Court approval because the LLC was still wholly owned by the College, which was a not-for-profit corporation.
The Court subsequently approved the earlier transfer of the Property to the LLC,[xxi] as well as the sale of the Property by the LLC to the Purchaser, subject to a hearing of the creditors. Following this hearing, the Court approved the LLC’s sale of the Property. The Lender’s loan was repaid from the proceeds of the sale.
The Letter Ruling
Surprisingly, an issue arose regarding the imposition of the RPTT to the sale of the Property.
The College asserted that the only tax that the Court ordered to be paid was the New York State Real Estate Transfer Tax.
However, the title company for the transaction took the position that it could not guarantee that the LLC was exempt from NYC’s RPTT. Consequently, the Purchaser refused to close the transaction without the LLC paying the RPTT and requesting a letter ruling from the NYC Dept. of Finance (the “DOF”) that the LLC’s transfer of the Property to the Purchaser was exempt from the RPTT as a transfer from a corporation organized and operated exclusively for educational purposes.[xxii]
Last month, the DOF responded to the College’s request.[xxiii] For the reasons set forth below, the DOF found that the LLC’s sale of the Property was subject to the RPTT.
The Exemption
The DOF began by explaining that, except to the extent an exemption applies, the RPTT bears on every transfer of an interest in NYC real property when the consideration for the real property or economic interest therein exceeds $25,000.[xxiv]
Next, the DOF described the exemption at issue,[xxv] pursuant to which the RPTT does not apply to the transfer of real property, or of an economic interest therein, by or to any Exempt Org.
The DOF noted “the substantial similarity” between an Exempt Org under the RPTT and an organization described in Section 501(c)(3) of the federal Internal Revenue Code (“IRC”), which exempts certain religious, charitable, and educational organizations from federal income tax.[xxvi]
According to the DOF, because of this substantial similarity between a “charitable” organization that is exempt from the RPTT and one that is exempt from federal income tax, the DOF has long taken the position that an organization exempt from tax under IRC Section 501(c)(3) would also be considered exempt from the RPTT.
The DOF observed that because the College was recognized as an exempt charitable organization for federal tax purposes, if the College were to directly sell the Property to the Purchaser, there would be no question that the sale would be exempt from the RPTT.
The LLC as Seller
However, the question presented to the DOF by the letter ruling request was whether the same exemption would apply to the transaction between the LLC and the Purchaser.
The College contended that its situation was “directly on point and analogous” to the facts described in an earlier DOF Ruling. The DOF did not agree.
The relevant facts of the earlier ruling were as follows: The applicant was an education corporation, chartered by the New York State Education Department, that owned certain real property through a limited liability company. Under its operating agreement, the individual members of the limited liability company held such membership as nominees of the applicant and were required to act with respect to their membership as the applicant directed. Absent a court order, the limited liability company’s members were prohibited from transferring their membership interest to any person other than the applicant. The DOF determined that (i) the limited liability company’s sole purpose was to own and hold the property for the applicant, (ii) the limited liability company’s members were required to act as the applicant directed, and (iii) the applicant had complete ownership and control over the limited liability company. The DOF determined that the limited liability company had no purpose other than to own and hold the property for the benefit of the applicant and engaged in no other activity. Under these facts and circumstances, the DOF found that the transfer of the property by the limited liability company to a developer was exempt from the RPTT.[xxvii]
The DOF pointed out that the earlier ruling, above, was explicitly not intended to apply broadly. Indeed, the ruling stated that it was “in derogation of the general rule” that “[t]he transfer of real property by or to an entity that is legally separate from . . . [a charitable] organization . . . would, ordinarily, not be exempt from RPTT.”
Lender as Beneficiary
The DOF explained that the situation of the College and the LLC was distinguishable from that of the limited liability company in the earlier ruling. Specifically, the applicant’s complete control of the limited liability company in the earlier ruling was central to the basis of that ruling’s conclusion.
In contrast, the DOF determined that the College did not have complete control over the LLC, and the LLC’s purposes were not exclusively to benefit the College. Rather, the Lender was an intended third-party beneficiary of the LLC’s Operating Agreement.
The Lender insisted on an independent director who could not be replaced without cause and without prior notice. The independent director was required to consider only the interests of the LLC,[xxviii] including its creditors. The independent director owed no fiduciary duty to and, in taking actions such as voting, was prohibited from considering the interests of members, other affiliates of the LLC or any group of affiliates.
DOF’s Conclusion
These terms, the DOF stated, comported with the “economic reality” of the situation, as the Lender had provided the College with a loan in an amount roughly equal to two-thirds[xxix] of the ultimate sales price of the Property and required that the structure of the LLC protect its interests.
Based on these facts, the DOF concluded that the LLC’s conveyance of the Property to the Purchaser was not exempt from the RPTT.
Observations: Debtor-Creditor
It is not at all unusual for a tax-exempt not-for-profit corporation to own real property through an LLC; after all, the LLC provides liability protection for its not-for-profit member, and it may be easier to organize and operate than a title holding company.
It is also not unusual for a not-for-profit to have borrowed funds secured by its real property, whether in connection with its acquisition or for capital improvements.
And of course, it is expected that the charity’s lender will endeavor to protect its investment, and its security interest in the related collateral, to a degree that is commensurate with the creditworthiness of its borrower.[xxx]
Moreover, the customary protective measures taken by a lender do not, by themselves, change the lender’s relationship to the property in which it has a collateral interest, let alone its status vis-à-vis its borrower.
For example, the lender’s insistence that their charity-borrower use a bankruptcy remote LLC (of which the charity is the sole member) to hold the collateral, and that the lender have a vote on certain major decisions regarding the disposition of the collateral, do not convert the lender into an equity owner of the property.
Nor does it support the characterization of the lender as a “beneficiary” of the charity, or of its wholly owned LLC, in a capacity other than that of a prudent lender. The foregoing measures do not grant the lender preferred use of the property or the right to participate in its profits or appreciation in value beyond what is needed to service and repay the loan.
Can one say that the lender stands in the shoes of an owner when it does not hold legal title to, does not have possession of, and does not have decision-making authority over, the property and its operations beyond what is reasonably necessary to protect its loan? Or where the collateral, as in the case of the Property, is not underwater – indeed, where one-third of its fair market value represents the LLC’s (the Charity’s) equity in the Property?
Observations: Income Tax Status
Where the not-for-profit parent is the only member of the LLC, and the LLC has not elected to be treated as a corporation for tax purposes,[xxxi] the LLC is disregarded as an entity separate from its parent not-for-profit. Consequently, the parent is treated as owning the income, assets, and liabilities of the LLC, the activities of the LLC are treated as having been conducted by the parent, and the LLC does not have to file its own income tax return.[xxxii] Moreover, the parent’s tax-exemption from income tax “attaches” to the income and gains realized by the LLC.[xxxiii]
Concededly, the items set forth in the immediately preceding paragraph relate to the income tax, not the RPTT. Still, the DOF itself admitted that the substantial similarity between an Exempt Org under the RPTT and an organization described in Section 501(c)(3) of the Code justify the DOF’s equating an organization’s exemption under Section 501(c)(3) with its exemption from the RPTT.
A Section 501(c)(3) organization must not be organized or operated for the benefit of private interests. No part of the net earnings of such an organization may inure to the benefit of any person having a personal and private interest in the activities of the organization.
Nothing in the letter ruling indicates that any income or assets of the College or the LLC inured to the benefit of the Lender in other than a commercially appropriate, arm’s length manner.
On short, I think the DOF’s ruling missed the mark.
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[i] https://comptroller.nyc.gov/reports/annual-state-of-the-citys-economy-and-finances-2024/. The City’s FY ends on June 30.
The NYC Council estimates approximately $1.225 billion of RPTT for the FY 2025. https://www.tax.ny.gov/research/collections/fy_collections_stat_report/2023-2024-annual-statistical-reports.htm.
By contrast, New York State collected approximately $1.165 billion of Real Estate Transfer Tax for its FYE March 31, 2024. https://www.tax.ny.gov/research/collections/fy_collections_stat_report/2023-2024-annual-statistical-reports.htm.
[ii] https://comptroller.nyc.gov/reports/popular-annual-financial-reports/#:~:text=In%20Fiscal%20Year%202024%2C%20program,settle%20overpayments%20by%20the%20taxpayers..
[iii] https://comptroller.nyc.gov/reports/annual-state-of-the-citys-economy-and-finances-2024/#iii-the-state-of-the-citys-finances.
[iv] As each of such terms are defined in NYC Admin. Code Sec. 11-2101.
[v] Admin. Code Sec. 11-2102. And don’t forget the New York State Real Estate Transfer Tax. See Article 31 of the New York Tax Law.
[vi] This exemption does not apply with respect to an organization that is operated for the primary purpose of carrying on a trade or business for profit, whether or not all of its profits are payable to one or more qualifying organizations.
It should be noted that the State has no comparable exemption for its Real Estate Transfer Tax.
[vii] Like other consumers, students and their families ultimately bear the cost.
[viii] IRC Sec. 501(a).
[ix] Presumably using the proceeds to cover operating expenses. Query whether it also implemented any cost-saving measures.
[x] Generally, one that is formed to own and operate a single project or property; specifically, the property securing the loan. By limiting the LLC’s purposes and activities, prohibiting it from incurring any other debt, and providing for an independent director in the LLC’s organizational documents, the lender hopes to reduce the risk that the LLC will go into bankruptcy.
[xi] The LLC was disregarded for income tax purposes. Treas. Reg. Sec. 301.7701-3(b)(1)(ii).
[xii] For a very good discussion of the implied covenant of good faith and fair dealing, see here: https://www.americanbar.org/groups/business_law/resources/business-law-today/2024-february/when-can-covenant-good-faith-fair-dealing-be-invoked/.
[xiii] The LLC did not have employees at any time.
[xiv] Whether by majority, or by most supermajority, voting requirements.
[xv] Combined Real Estate Transfer Tax Return, Credit Line Mortgage Certificate, and Certification of Exemption from the Payment of Estimated Personal Income Tax for the Conveyance of Real Property Located in New York City.
[xvi] Admin. Code Sec. 11-2106(b)(8). The fact there was consideration for the transfer in the form of the debt to which the Property was subject did not disqualify the transfer from the “mere change” exemption.
[xvii] Return of Organization Exempt from Income Tax.
[xviii] Specifically, Schedule R of Form 990 indicated that the College was the direct controlling entity of the LLC, which was a disregarded entity.
[xix] In accordance with Not For Profit Corporation Law sections 510(a)(3), 511, and 511-a(a)
[xx] Pursuant to Not For Profit Corporation Law section 511-a.
[xxi] Pursuant to Not For Profit Corporation Law sections 510 and 511.
[xxii] Admin. Code Sec. 11-2106(b)(2).
[xxiii] Request for Ruling Real Property Transfer Tax FLR 24-5033 (January 22, 2025).
[xxiv] Admin. Code Sec. 11-2102(a), (b), Sec. 11-2106.
[xxv] Admin. Code Sec. 11-2106(b)(2).
[xxvi] The following organizations are described in IRC Sec. 501(c)(3): “corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation . . . , and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”
[xxvii] Under Admin. Code Sec. 11-2106(b)(2).
[xxviii] As opposed to those of the College? Query how they differed.
[xxix] But not 100%.
[xxx] It’s standard commercial practice, though having a “representative” on the board indicates an especially risky loan.
[xxxii] In fact, donations to the LLC may be eligible for a charitable deduction. IRS Notice 2012-52.
[xxxiii] If the LLC files its own exemption application, Form 1023, the LLC is treated as a corporation for tax purposes.