Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
How many Wholesalers doing Double Closings are paying the Real Estate Transfer Taxes?
These can be quite expensive in some places. For instance The State of Pennsylvania charges 1% of the sales price and the municipality and school district USUALLY charge 1% between them for a total of 2% (i.e. 2% X 100,000 = $2,000). By custom, the buyer and seller split the cost.
Before a deed, security instrument, or other writing can be recorded in the office of the clerk of the superior court, the real estate transfer tax must be paid. If a Wholesaler does a double closing in PA the transfer costs could amount to 4% - Failure to pay those costs will create a problem for the end buyer and anyone who subsequently buys from them.
Many Counties are now looking at increasing the rates in order to obtain more revenue. Who knows how much you should be paying in each State and particular Counties and Cities?
When you look at possibly paying 4% in transfer costs on a double closing (or at least half of that - as the end buyer would pay half) does paying $10,000 on a $500,000 house seem a bit dumb? Especially when you can keep closing costs down to under $1,000 by not double closing?
How are wholesalers managing the payment or non-payment of transfer tax?
Very good question. Right now, probably the best "legal" way to do it is to use an option contract. The basic idea is to have the seller grant you an option to buy the property. You record a memorandum of option with the recorder of deeds to let the world know that you have this option. You do this for various reasons including preventing the seller from selling the property to another buyer without your knowledge. After you record the memorandum, you then go around finding a buyer. There are different ways to handle it from there, but all options basically involve you releasing the option for a fee so that the buyer can buy the property from the seller. Done correctly, this method will not trigger a double transfer tax.
THIS DOES NOT necessarily mean that you as a wholesaler are otherwise complying with the law. This is especially true if you try to wholesale without being a salesperson or a broker. Now some argue that the government is infringing on your due-process rights by preventing you from trying to sell your property rights. You could try to make that argument. But I’m going to guess that the Commonwealth of Pennsylvania and their attorneys have more time and money than you when it comes to litigation.
A lot of wholesalers decide to just ignore the taxes and hope for the best. For example, many wholesalers just assign the contract to the buyer and hope that no one notices. Since the Department of Revenue relies heavily on recorded documents to collect realty transfer taxes, many wholesalers are able to avoid prosecution. But if you get caught, you are potentially dealing with tax-evasion charges.
If I was a wholesaler, my biggest concern would be a disgruntled seller or buyer reporting your actions to the Pennsylvania Real Estate Commission or the Attorney General’s Office. Filing a complaint with them is free and they do try to look into all the complaints (even if it takes a while to start). If you get caught after only a few deals, hopefully you can plead ignorance and just pay a fine of few thousand dollars. But if your entire business model depends on ignoring realty transfer taxes or licensing laws, then you might face a bigger problem.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information
Very good question. Right now, probably the best "legal" way to do it is to use an option contract. The basic idea is to have the seller grant you an option to buy the property. You record a memorandum of option with the recorder of deeds to let the world know that you have this option. You do this for various reasons including preventing the seller from selling the property to another buyer without your knowledge. After you record the memorandum, you then go around finding a buyer. There are different ways to handle it from there, but all options basically involve you releasing the option for a fee so that the buyer can buy the property from the seller. Done correctly, this method will not trigger a double transfer tax.
THIS DOES NOT necessarily mean that you as a wholesaler are otherwise complying with the law. This is especially true if you try to wholesale without being a salesperson or a broker. Now some argue that the government is infringing on your due-process rights by preventing you from trying to sell your property rights. You could try to make that argument. But I’m going to guess that the Commonwealth of Pennsylvania and their attorneys have more time and money than you when it comes to litigation.
A lot of wholesalers decide to just ignore the taxes and hope for the best. For example, many wholesalers just assign the contract to the buyer and hope that no one notices. Since the Department of Revenue relies heavily on recorded documents to collect realty transfer taxes, many wholesalers are able to avoid prosecution. But if you get caught, you are potentially dealing with tax-evasion charges.
If I was a wholesaler, my biggest concern would be a disgruntled seller or buyer reporting your actions to the Pennsylvania Real Estate Commission or the Attorney General’s Office. Filing a complaint with them is free and they do try to look into all the complaints (even if it takes a while to start). If you get caught after only a few deals, hopefully you can plead ignorance and just pay a fine of few thousand dollars. But if your entire business model depends on ignoring realty transfer taxes or licensing laws, then you might face a bigger problem.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information
Tnx Chris - the option track might be a way of skirting the problem - however, that contract still falls under the heading of a transfer of an interest in real estate, which in my eyes makes it dutiable.
A simple solution which avoids assignment is using a C Corp as the contracting purchaser. The deal completes without there being need for assignment or double closing - only matters are the transfer of ownership and control of the C Corp. There does not even need to be a transfer of shares in the C Corp for this to work.
(I was a corporation lawyer working in the Securities Industry for years before switching to real estate - now I prefer to operate as a Financial Management Consultant)
1. Pennsylvania has modified its realty-transfer-tax statute many times over the years. For example, the legislature expressly modified the applicable statutes so that assignments of an agreement of sale are a taxable event. To my knowledge, the current statute is entirely silent on whether the termination of an option is a taxable event, and the Department of Revenue has not yet addressed it either using a publication. Pennsylvania law is clear that when there is an ambiguity in a tax statute, the courts must generally interpret the ambiguity in favor of the taxpayers. So while no one can predict with complete accuracy about how a court would rule, I have a hard time seeing how the Commonwealth can successfully tax the "option method" without amending the realty-transfer-tax statute.
2. Not sure if I follow your C-Corp idea, but the Commonwealth treats the transfer of ownership interests in a "real-estate company" as a taxable event. When lawyers tried to find ways to get around this problem, the Commonwealth has historically responded by making it more difficult for them to do so. For example, a popular way to avoid real-estate transfer taxes when selling real-estate companies was to use what we called the "89/11" method. In 2014, legislatures modified the statute so that it became very hard for lawyers and their clients to use that method. You can read more about the 2014 changes on this issue in the link below.
3. There is also the issue of whether you want to hold real-estate in a C-Corp. I'm not a CPA nor a tax lawyer but many experts appear to agree that there are many reasons for why most folks should never do so. I've worked on some cases where a C-corp owned highly appreciated real estate --- despite working with good CPAs and tax lawyers, the tax consequences were never pretty no matter what option the C-Corp used.
4. Not to go off on a tangent, but I am curious to see if any CPAs or tax lawyers on BP could give us any good reason why a C-Corp should own real estate.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information
Ok. I dont wholesale, but I was intrigued by this thread and read the article @Chris K. posted.
I know you are not an estate planning attorney, but in theory based on that article, I could structure my will to gift my heirs 89% of my real estate company at my death and then after 3 years and 1 day I could transfer them the final 11% and not be subject to realty transfer taxes. Although I am assuming it would still be subject to inheritance tax at each distribution.
Actually, I did do work on estate planning matters in my previous life. But I wouldn't call myself a specialist since most estate-planning lawyers now also have to practice in the realm of elder law as well. Note that estate planning questions are not easy to answer on BP since they can be fact intensive. So you should go talk to your lawyer about it and do some estate planning (especially if you have kids).
With that in mind, here are some general comments:
1. I would say that in many cases, you probably don't need to worry about realty transfer taxes because there are various exemptions. But it depends on how you want to divide up your estate to your kids. For example, let's say you end up with a very successful real-estate business. One of your kids gets heavily involved in the business while others don't. How do you want to divide up the estate?
2. As for avoiding PA inheritance taxes, you really want to talk to a lawyer about it. There are ways to do so but they all have different pros and cons.
3. I would also note that serious estate planning is really an on-going process until you die. The estate-planning tools vary drastically depending on your current and expected net worth. For the majority of people (who will die without any meaningful net worth), you could probably do their estate planning for around $1,000 and cover virtually all concerns. Maybe add a few thousand dollars if they need Medicaid planning or have some other special circumstances (e.g. special needs child).
For folks who already have a high net worth or have reason to believe that they will have such net worth, the estate-planning tools become rather different. You will likely need to have fairly regular meetings with your CPA, lawyers, and other members (e.g. wealth managers).
4. So when do you know you need to do some serious estate planning? That get's tricky to answer, but here are numbers to consider. As of today, married couples basically enjoy federal inheritance tax exemptions up to $10.9 million. So if you expect to have more than that amount, you obviously need to some serious estate planning. But you also need to consider the fact administrations can always change the exemption amount. I think Hillary Clinton wanted to reduce it to somewhere around $3.5 million. You could imagine that someone like Bernie would want to reduce it even lower. So you will always deal with some level of the "stroke of the pen risk."
On the Pennsylvania side, direct descendants (e.g. your children) will have to pay 4.5% in inheritance tax subject to various exemptions and exclusions. So you can try to predict your net worth and see how much inheritance taxes they will incur when you die.
Do note that there is an interesting trend now where states are trying to reduce or completely remove inheritance/estate taxes. Perhaps they are doing so to compete with states like Florida or Arizona where rich retirees tend to congregate due to numerous tax benefits.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.
The simple answer to avoiding transfer taxes in PA is to research the types of transfers that are exempt from transfer taxes, and to then figure out if there is a way to structure the transaction to be exempt ;)
WA has a steep excise tax on transfers as well, about 1.78%. It varies a little per county. This adds up quickly with a median home coming in at $258k. Over $400k on the coast.
You've got to learn your state transfer scenarios and types as @Steve Babiak mentions. Go and talk to your county treasurer if you have to.
I have an arsenal of ways to secure my interest without 'transferring'. I have memorandum of agreements and memorandum of options I record. I delay (up to 30 days here penalty-free) deed recording while having my seller execute 2 warranty deeds - 1 to 'blank' and 1 to me or my entity. I'll record the one that applies. If I go a little over - say, 45 days - the penalty is minimal.
I also own my larger commercial apts in LLCs. Here a sale of 50% or more of an entity triggers the transfer tax. That means 49% or less does not. I am a 48% owner, my wife 48% and my boys 2% each. To save $20k+ I'll have the option to draw out a sale over 3 calendar years. May get a little more difficult, but $20k is a few months of freedom in my book.
@Chris K. Instead of transferring shares of the C Corp all that is necessary is for a change in Control - the actual mechanics is simple - just use share dilution - and leave the original owner with the one or two shares they issued on incorporation. Hence there is no transfer or sale of the original shareholder's shares. The new majority share holder or an appointee becomes director and the settlement proceeds without assignment and no double closing
You might be wondering how they get paid? Another simple method - just use structured finance, the C Corp. should borrow from another entity so there is a loan to be repaid (with or without interest)
There are many tax advantages of utilizing a C Corp. which the average CPA even is unaware. The downside in Holding Property in it is obviously the Capital Gains trap - where there is no offset like an LLC and personal holding. The advantages of being able to hold and borrow against property in a C Corp. eliminates tax - assuming you never intend to sell the property. Thus there is no tax consequences. In the event a sale is needed there are ways to make the transfer and through financial structuring have an offset to ameliorate potential gains tax.
- Not wanting to disclose too much details for proprietary reasons. (apologies for that)
Persons wanting more info can get that if they wish to partner up on some deals.
Regarding Estate Planning - I had a number of attorneys as clients whom I advised in respect of their client's Estate Planning and Tax as well as for their own personal needs. The preferred approach was Corporate structuring while the donor was still alive. That obviated the need for Trusts and Wills, which avoided Probate. There was never a need to liquidate assets (thus side stepping capital gains tax which might apply on the death of the benefactor).
I was a licensed financial planner before becoming a practicing lawyer - specializing in Business Organization, Tax and Asset Protection.
Disclaimer: The above does not constitute legal advice. I wrote the above for informational purposes. Do not rely on it as legal advice.
But setting aside the tax issues, I don't see how an average wholesaler could possibly utilize this C-Corp strategy. If I understand your suggestion, you are saying that the wholesaler should: (1) create a C-Corp; (2) give him or herself one or two shares; (3) enter into a sale agreement using that C-Corp; (4) find a buyer that is willing to become the majority shareholder of the C-Corp that owns this property using share dilution. There are many concerns with this:
First, I am fairly certain that the PA Department of Revenue does not care whether you use share dilution to create a new majority shareholder. The basic test is whether a new party gains at least 90% of the ownership/shareholder/membership interest in the existing entity. If there is a 90% swing, it's a taxable event no matter how you do it. This means the wholesaler must always keep at least 10.0000000001% interest in the C-Corp for at least 3 years.
Second, most buyers who work with wholesalers are investors. Most investors will eventually want to sell the property. In fact, many buyers are flippers who need to sell the property to an average homebuyer. This C-Corp idea makes that very difficult.
Third, I also don't know if the above scenario raises any concerns with the SEC. Maybe the wholesaler will be fine under the Howey Test due to the fourth element. But some wholesalers do offer "hybrid" deal where they offer to handle the rehab and otherwise provide comprehensive services to the buyer as part of the deal. If that's the case, I think the wholesaler might end up in dangerous waters.
Fourth, why go through all the trouble when the option method is still available? Wholesalers already need to worry about whether they are violating state law on real-estate licensing requirements. This method seems to add another level of concern to solve a problem that they can easily slow for a few hundred dollars. Perhaps it's a solution to ponder in other states, but I don't see wholesalers needing to use this method in Pennsylvania.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.
1. Yes how the shareholding is important - but you see that is a easily dealt with - it is just a matter of the change not exceeding the 89% threshold.
2. I structure deals buying only from owner occupiers - (again proprietary stuff) - there are no tax consequences for early sales - meaning even immediately - and the C Corp provides far better Asset Protection, makes it more acceptable for finance, and is much easier than trying to transfer membership of an LLC which some wholesalers d.
3. SEC is not too concerned - as it is a one off deal. Each deal needs a New C Corp. and that will not come up on the radar.
4. Tax can be managed easily via the C Corp - but hardly possible using the option approach. Wholesalers who like money are better served with the C Corp - more profits and less tax. There are also side benefits which relate to financing being more easily obtainable, and overcoming the seasoning problem.
@Chris K. Great info, thanks! Do you have an option contract for wholesaling that you could share with me? I'm looking to save money on transfer taxes. Thanks!