Tips on How to Avoid Surprise Tax Liabilities When Transferring Business Ownership Control in Washington State and Facts About  Real Estate Excise Tax on Controlling Interest Transfers

For those business owners and legal professionals new to working with Washington state’s taxation system, the controlling interest transfer rules and the Real Estate Excise Tax (REET) liability can come as a nasty surprise in business ownership contract of changes. We checked in with Brett T. Sullivan, Fennemore Spokane for insights on Washington’s Real Estate Excise Tax on Controlling Interest Transfers.

What does the REET apply to?

In Washington state, the Real Estate Excise Tax (REET) applies not only to direct sales of real property but also to transfers of controlling interests in entities that own real property within the state. A “controlling interest” is defined as 50% or more of the total voting power or capital, profits, or beneficial interest in an entity. This provision, known as the “controlling interest transfer” rule, is found in WAC 458-61A-101 and ensures that transactions involving significant ownership changes within entities like corporations, limited liability companies, and partnerships that own real estate are subject to taxation, even when the property title remains unchanged.

Can you explain the REET rates and who is responsible for paying them in the sale of the property?

The REET rates are graduated based on the selling price of the property. When a controlling interest is transferred, the tax is calculated based on the “true and fair” value of all real property owned by the entity at the time of the transfer. Typically, the seller is responsible for paying the REET. However, if the seller does not pay, the buyer becomes liable, and any unpaid tax can create a lien on the property. 

It’s important to note that certain exemptions may apply, and the specifics of each transaction can affect tax liability. REET is calculated as a percentage of the “true and fair value” (typically the selling price) of the real property sold in a transaction using a graduated rate structure. Here is a summary of Washington state REET Rates (Effective January 1, 2023):

1. First $525,000 of sales price: Taxed at 1.10%
2. Next $1,000,000 of sales price ($525,000.01 to $1,525,000): Taxed at 1.28%
3. Next $1,500,000 of sales price ($1,525,000.01 to $3,025,000.00): Taxed at 2.75%
4. Portion of sales price exceeding $3,025,000.00: Taxed at 3.00%

For an LLC (even one that is registered in a different state) that owns real property in Washington state with a true and fair value of $10,000,000, if a controlling interest transfer occurs, the REET (not including the local REET as described above) is $269,075.

In addition to the state tax, local jurisdictions may impose their own REET, typically ranging from 0.25% to 0.50%, depending on the location.

What are the challenges that arise when dealing with REET on controlling interest transfers?

1. Defining Controlling Interest: A ‘controlling interest’, as we defined, is 50% or more of the voting power or capital, profits, or beneficial interest in an entity. Determining when this threshold is met can be complex, especially in entities with multiple owners holding different classes of ownership interest.
2. Defining the Taxable Transfer Period: Effective January 1, 2020, the period for assessing whether a controlling interest has been transferred was extended from 12 to 36 months. This means that multiple smaller transactions within a three-year span can cumulatively trigger REET if they result in a 50% or greater change in ownership.
3. Determining the Valuation: REET is calculated based on the “true and fair value” of all real estate located in Washington state that is owned by the entity at the time of the transfer. Accurately determining this value is crucial for compliance.
4. Clarifying Exemptions and Exclusions: Certain transfers may be exempt from REET, such as gifts or inheritances. However, qualifying for these exemptions requires meeting specific criteria, and misinterpretation can lead to unintended tax liabilities.

Can you provide some practical advice for navigating REET on controlling interest transfers?

1. Know Before You Go: Before executing any transfer of ownership in an entity that owns real property in Washington state, thoroughly assess whether the transaction constitutes a transfer of a controlling interest.
2. Monitor Cumulative Transfers: Keep detailed records of entity ownership changes over a rolling 36-month period to identify potential cumulative transfers that might trigger REET.
3. Accurate Valuation: Engage qualified appraisers to determine the true and fair value of the real property owned by the entity at the time of transfer.
4. Seek Professional Guidance: Consult with legal and tax professionals experienced in Washington’s REET laws to navigate complexities and ensure compliance.
5. Report and Pay on Time: A special form is used to report a controlling interest transfer and pay any REET that is due.
6. Navigating Washington state’s REET regulations on controlling interest transfers requires meticulous attention to detail and a thorough understanding of the law governing the transfer of controlling interests. Given the complexities and potential financial implications, consulting with experienced legal professionals is essential to ensure compliance and optimize tax outcomes.

Brett T. Sullivan is a Director in Fennemore’s Business and Litigation Practice Group. He focuses on real estate and business law, with a particular emphasis on the intersection of these two areas. He advises individuals and businesses in all aspects of business and entity formation, management, governance, financing, operations, and business closings. His clients include real estate investors, developers, and syndication groups across Washington state. Brett advises business clients on asset and equity sale transactions and has acted as a closing agent on numerous business purchase and sale transactions. Additionally, he provides a full spectrum of services to homeowners and condominium owners associations.