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State & Local Tax Bulletin (July 2000)

Recent Legislative Changes May
Reduce Potential California
Transfer Tax Liability

By Kerne Matsubara, now a tax partner in the San Francisco office of Pillsbury Winthrop Shaw Pittman LLP. If you have or can obtain the Acrobat Reader, or have an Acrobat-enabled web browser, you may wish to download or view our July 2000 State & Local Tax Bulletin (a 127K pdf file), containing a printed version of this article and also available via ftp at ftp.pmstax.com/state/bull0007.pdf.

This bulletin concerning California state and local tax matters is part of the Tax Page, a World Wide Web demonstration project, no portion of which is intended and cannot be construed as legal or tax advice. Comments are welcome on the design or content of this material.

Transfer taxes usually do not take center stage when structuring or negotiating corporate transactions. However, with the recent escalation in the value of real estate and the growing use of limited liability companies (LLCs), taxes imposed upon the transfer of real property have become an increasingly important issue for many taxpayers. Fortunately for taxpayers, the California Legislature recently has enacted legislation that may enable taxpayers to minimize their potential transfer tax liability.


Many states and localities have imposed a tax on the transfer of property located within the state or locality. The tax, known as the documentary transfer tax or real property transfer tax (hereinafter, the "transfer tax"), is largely based on the federal documentary stamp tax, which was repealed in 1976.[fn. 1] In California, counties and cities have been authorized to impose a tax on deeds of transfer of realty located within such county or city.[fn. 2] The amount of the tax is based on the consideration or value of the realty transferred. The county rate is fifty-five cents ($0.55) for each five hundred dollars ($500) of value, and the noncharter city rate is one-half of the county rate and is credited against the county tax due.[fn. 3] Charter cities, however, may impose transfer taxes at a rate higher than the county rate.[fn. 4] The transfer tax must be paid by the person who makes, signs or issues any document subject to the tax, or for whose use or benefit the document is made, signed or issued.[fn. 5]

"Tax-Free" Transactions May be Subject to California Transfer Tax

A merger, reorganization or other corporate transaction that is "tax-free" for purposes of federal income or state franchise or corporation income tax is not necessarily free from transfer tax. In addition, tax-free transfers of realty involving partnerships or LLCs may be subject to transfer tax in California, even though partnerships and some LLCs are treated as "passthrough" entities for federal and California income tax purposes. For example, a transfer of realty to a corporation or partnership that is not subject to federal income tax under IRC § 351 or IRC § 721, respectively, may be subject to transfer tax. Similarly, transfers of realty pursuant to a reorganization under IRC § 368 or a spin-off under IRC § 355 also may be subject to transfer tax. Thus, the transfer tax generally should apply to transactions involving the transfer of realty, including "tax-free" transactions, unless otherwise exempted.

Statutory Exemptions from Transfer Tax

The California Revenue and Taxation Code, which provides the statutory authority for counties and cities to impose the transfer tax, specifically exempts from tax the following transactions:

  • Instruments in writing given to secure a debt,[fn. 6]

  • Transfers whereby the federal or any state government, or agency, instrumentality or political subdivision thereof, acquires title to realty,[fn. 7]

  • Transfers made to effect a plan of reorganization or adjustment (i) confirmed under the Federal Bankruptcy Act, (ii) approved in certain equity receivership proceedings or (iii) whereby a mere change in identity, form or place of organization is effected,[fn. 8]

  • Certain transfers made to effect an order of the Securities and Exchange Commission relating to the Public Utility Holding Company Act of 1935,[fn. 9]

  • Transfers of an interest in a partnership (or, beginning January 1, 2000, an entity treated as a partnership for federal income tax purposes) that holds realty, if (i) the partnership is treated as continuing under IRC § 708 and (ii) the continuing partnership continues to hold the realty,[fn. 10]

  • Certain transfers in lieu of foreclosure,[fn. 11]

  • Transfers, divisions or allocations of community, quasi-community or quasi-marital property between spouses pursuant to, or in contemplation of, a judgment under the Family Code,[fn. 12]

  • Transfers by the State of California, or any political subdivision, agency or instrumentality thereof, pursuant to an agreement whereby the purchaser agrees to immediately reconvey the realty to the exempt agency,[fn. 13]

  • Transfers by the State of California, or any political subdivision, agency or instrumentality thereof, to certain nonprofit corporations[fn. 14] and

  • Transfers pursuant to certain inter vivos gifts or inheritances.[fn. 15]

Because the RTC provides the authority by which counties may impose the transfer tax, California's counties have adopted ordinances that generally provide for the above set of exemptions. However, the manner in which each county applies and interprets the above exemptions may vary greatly. In addition, because charter cities are not strictly bound by the transfer tax provisions of the RTC, the potential exists for even greater non-uniformity in the transfer tax area. As discussed below, the local county rules should be reviewed to determine whether a particular transaction will be exempt from transfer tax.

Recent California Rules Regarding LLCs and Other Legal Entities

In 1996, the California Legislature began to address the issue of whether transfer tax should apply when existing business entities such as corporations or partnerships convert into or transfer real property to LLCs.[fn. 16] In 1998, the Legislature exempted such conversions or transfers from transfer tax, provided that the direct or indirect proportionate interests in the real property remained the same.[fn. 17] However, because such exemption was not codified in the RTC, some county recorder's offices refused to honor the exemption.[fn. 18]

In 1999, the California Legislature not only clarified but also broadened the transfer tax exemption by enacting legislation codified as RTC § 11925(d).[fn. 19] RTC § 11925(d), effective January 1, 2000, provides:

    No levy shall be imposed pursuant to this part by reason of any transfer between an individual or individuals and a legal entity or between legal entities that results solely in a change in the method of holding title to the realty and in which proportional ownership interests in the realty, whether represented by stock, membership interest, partnership interest, cotenancy interest, or otherwise, directly or indirectly, remain the same immediately after the transfer.

Thus, the direct or indirect proportionate interests in the real property must remain the same before and immediately after the transfer for the exemption to apply. The following examples illustrate the application of the exemption under RTC § 11925(d).

    Example 1. Corporation X transfers realty to its wholly-owned subsidiary, Corporation Y, in a transaction described under IRC § 351. Such transfer is exempt from transfer tax under RTC § 11925(d), because Corporation X's direct or indirect interest in the realty is the same both before (i.e., 100%) and immediately after (i.e., 100%) the transfer.

    Example 2. Same as Example 1, except that Corporation X owns 99 percent of the stock of Corporation Y. Such transfer is not exempt from transfer tax under RTC § 11925(d), because Corporation X's direct or indirect interest in the realty is not the same before (i.e., 100%) and immediately after (i.e., 99%) the transfer.

    Example 3. Partner A and Partner B each own a 50 percent undivided interest in realty. Partner A and Partner B each contribute their 50 percent interest in the realty to Partnership AB, in which each partner will own a 50 percent interest after the transfer. The transfer is exempt from transfer tax.

    Example 4. Member A transfers realty to an LLC, the interests of which after the transfer are owned 60 percent by Member A and 40 percent by an unrelated member, Member B. The LLC is treated as a partnership for federal income tax purposes and the transfer is not subject to federal income tax under IRC § 721. Such transfer is not exempt from transfer tax under RTC § 11925(d) because Member A's direct or indirect interest in the realty is not the same before (i.e., 100%) and immediately after (i.e., 60%) the transfer. But see infra text accompanying note 24 (under which a partial exemption from transfer tax may be possible).

Additional Sources of Legal Authority to Claim Exemption from Tax

The RTC provides the statutory basis for counties to impose the transfer tax. However, because the RTC transfer tax provisions were patterned after the former federal documentary stamp tax, federal administrative regulations and interpretations of the federal tax arguably should apply to the California transfer tax.[fn. 20] Application of the former federal regulations and rulings may provide additional exemptions or partial exemptions from the transfer tax, including, but not limited to, the following transfers:

  • Non-donative transfers for no consideration,[fn. 21]

  • A transfer from an agent to its principal of real estate purchased for and with funds of the principal,[fn. 22]

  • Transfers of real estate in a statutory merger or consolidation (e.g., under IRC § 368(a)(1)(A)) from a constituent corporation to the continuing or new corporation[fn. 23] and

  • Conveyances of realty from a partner to a partnership, subject to transfer tax only to the extent that the conveyance is a transfer of an undivided interest in the realty to members of the partnership other than the transferor.[fn. 24] Example. Partner A transfers a wholly-owned parcel of real property to Partnership AB, in which Partner A will own a 60 percent interest after the transfer. Such transfer should be subject to transfer tax only to the extent of 40 percent of the fair market value of the real property.

As mentioned above, because the transfer tax is applied at the county level, the transfer tax may not be imposed uniformly throughout all California counties. Each county generally has enacted its own local transfer tax ordinance and many county recorder's offices have published their own guidance regarding exempt transfers. Because some counties may provide for more generous exemptions than others, county ordinances and published guidance can be good sources of information.[fn. 25] The California Highway Patrol maintains a list of links to the internet websites of California counties. For greater assurance that a particular transaction will not be subject to transfer tax, taxpayers may seek a ruling or determination letter from the appropriate county recorder.

Special Rules Regarding Liens, Encumbrances and Assumptions of Mortgages

Liens and encumbrances remaining of property. The transfer tax generally is imposed on the amount of the consideration or value of the real property conveyed, exclusive of the value of any lien or encumbrance remaining on the property at the time of transfer or sale.[fn. 26] Thus, transfer tax is imposed on the net consideration paid for, or the net value of, the realty conveyed. The amount of the net consideration or net value should be determined by subtracting from gross consideration or gross value, the amount of all liens or encumbrances on the realty existing before the sale and not removed thereby.[fn. 27] Thus, the amount of any liens or encumbrances on the realty are excluded from the transfer tax base, provided that the lien or encumbrance (i) existed before the sale and (ii) is not removed from the property by or in the sales transaction.[fn. 28]

Assumptions of mortgages and other liabilities. Where the buyer or transferee acquires realty and assumes the debts or mortgage of the seller or transferor, the amount of such debts or mortgage may constitute consideration for transfer tax purposes.[fn. 29] Under this analysis, where the buyer or transferee acquires realty and other assets in connection with the transfer, the amount of the debt or mortgage is allocated to such other assets based on the pro rata portion of the assumed liabilities not directly attributable to the realty.[fn. 30]

    Example. Corporation X receives as a liquidating distribution realty and other assets valued at $400,000 and $180,000, respectively, from Corporation Y. [fn. 31] Corporation X assumes the liabilities of Corporation Y consisting of a $220,000 mortgage on the realty and $60,000 not directly attributable to such realty. The gross consideration paid for the realty is the sum of (i) the liabilities assumed by Corporation X that are directly attributable to the realty (i.e., $220,000) and (ii) the pro rata portion of the liabilities assumed by Corporation X that are not directly attributable to the realty (i.e., $30,000). Such pro rata portion is determined by multiplying the ratio of the adjusted value of the realty of $180,000 (i.e., $400,000 fair market value less the $220,000 mortgage) to the adjusted value of all the assets transferred (i.e., $400,000 plus $180,000 less the $220,000 mortgage) by the amount of the liabilities not directly attributable to the realty (i.e., $60,000). Thus, the gross consideration is $250,000 (i.e., the assumed $220,000 mortgage plus the $30,000 pro rata portion of the assumed debt). The net consideration upon which transfer tax is imposed is $30,000 (i.e., $250,000 gross consideration less the $220,000 mortgage).

Step Transaction Doctrine May Apply

Although the incidence of transfer tax, similar to the sales and use tax, largely derives from the form of the taxpayer's transactions, county recorders may attempt to apply the step transaction doctrine to impose transfer tax on multi-step transactions.[fn. 32] For example, assume that Corporation X transfers realty to a single member LLC and subsequently conveys all of the interests in such LLC to an unrelated entity, Corporation Y. In form, the first step should be exempt from tax under RTC § 11925(d) and the second step should not be subject to tax because the transfer of interests in an LLC should not be regarded as a transfer of realty for transfer tax purposes. However, if the two steps are part of an integrated plan and are not separated by any length of time, the transaction may be susceptible to attack under the step transaction doctrine. Thus, where realty is transferred in a series of steps pursuant to a plan of reorganization or other corporate restructuring, taxpayers may wish to consult a tax advisor or seek a ruling or determination letter from the county recorder prior to the transaction.


  1. Former Internal Revenue Code ("IRC") § 4361.[return to text]

  2. California Revenue and Taxation Code ("RTC") § 11911(a), (b). Except for realty held by certain terminating partnerships, the transfer tax appears to apply strictly to the transfer of "lands, tenements, or other realty" and not to the transfer of interests in entities that may hold such realty. Compare RTC § 11911(a) with RTC § 64(c), (d) (transfer of ownership interests in legal entities that hold realty may be regarded as a change in ownership for property tax purposes) and IRC § 897(c) (transfer of interests in a corporation that holds realty may be treated as a disposition of real property for "FIRPTA" purposes).[return to text]

  3. RTC § 11911(c).[return to text]

  4. See Cal. Const. Art. XI, § 5.[return to text]

  5. RTC § 11912.[return to text]

  6. RTC § 11921.[return to text]

  7. RTC § 11922.[return to text]

  8. RTC § 11923. The exemption for a "mere change in identity, form or place or organization" under RTC § 11923(d) mirrors the language of IRC § 368(a)(1)(F). Thus, transfers of realty pursuant to an F reorganization should not be subject to transfer tax.[return to text]

  9. RTC § 11924.[return to text]

  10. RTC § 11925(a). In a partnership termination under IRC § 708, the terminating partnership is treated as having executed an instrument whereby all realty held by the partnership at the time of the termination was conveyed, for fair market value, less any liens or encumbrances remaining thereon. RTC § 11925(b). Only one tax may be imposed upon the termination of a partnership and any transfer of property made pursuant to the termination. RTC § 11925(c).[return to text]

  11. RTC § 11926.[return to text]

  12. RTC § 11927.[return to text]

  13. RTC § 11928.[return to text]

  14. RTC § 11929.[return to text]

  15. RTC § 11930.[return to text]

  16. See Cal. Stat. 1996, ch. 57, § 29 (SB 141) (declaring the Legislature's intent that such conversions or transfers shall not be subject to transfer tax).[return to text]

  17. Cal. Stat. 1998, ch. 514, § 3 (AB 2292).[return to text]

  18. See Robert S. Miller, Careful Structuring Takes Bite Out of Transfer Tax, San Francisco Daily Journal, Mar. 26, 1998. The refusal by some county recorders to apply this exception on such grounds appears unwarranted, because uncodified provisions enacted into law by the Legislature have equal force as law as codified provisions. See, e.g., County of Los Angeles v. Payne, 8 Cal. 2d 563, 574 (1937); Crespin v. Kizer, 226 Cal. App. 3d 498, 510 n.8 (1990); In re Kali D., 37 Cal. App. 4th 381, 386 & n.5 (1995).[return to text]

  19. Cal. Stat. 1999, ch. 75, § 1 (AB 1428). AB 1428 also provides that, for purposes of the exemption regarding the transfer of partnership interests under specified conditions, the term "partnership" shall include entities that are treated as partnerships for federal income tax purposes. See RTC § 11925(a); see also Treas. Reg. § 301.7701-2, 3 (relating to the classification of business entities for federal tax purposes). Thus, transfers of interests in a realty-holding LLC that is treated as a partnership for federal income tax purposes, should not be subject to transfer tax, provided that such transfer does not cause a termination under IRC § 708 and that the LLC continues to hold the realty.[return to text]

  20. See Brown v. County of Los Angeles, 72 Cal. App. 4th 665, 668 (1999); Thrifty Corp. v. County of Los Angeles, 210 Cal. App. 3d 881, 884 (1989); 82 Op. Atty. Gen. Cal. 56 (1999); 62 Op. Atty. Gen. Cal. 87, 89 (1979).[return to text]

  21. Former Treas. Reg. § 47.4361-2(b)(2); see also T.D. 6589, 1962-1 C.B. 228 (adopting the federal documentary stamp tax regulations). Note, however, that corporate stock received in exchange for a transfer of realty to a corporation may be regarded as consideration for transfer tax purposes. See Former Treas. Reg. § 47.4361-2(a)(7).[return to text]

  22. Former Treas. Reg. § 47.4361-2(b)(5).[return to text]

  23. Former Treas. Reg. § 47.4361-2(b)(12).[return to text]

  24. M.T. 4, 42-2 C.B. 275.[return to text]

  25. See, e.g., the taxpayer's guide, "Documentary Transfer Tax Status," which is available from the Registrar-Recorder/County Clerk of the County of Los Angeles.[return to text]

  26. RTC § 11911.[return to text]

  27. See former Treas. Reg. § 47.4361-1(b).[return to text]

  28. But see Rev. Rul. 54-197 (amount of the mortgage excluded from the transfer tax base, where realty is purchased subject to an existing mortgage, but the mortgage is not "removed by the sale" of the realty even though the purchaser agrees with the mortgagee to pay the mortgage at the same time that the purchaser takes title to the realty); Nassif v. Delaney, 522 U.S.T.C. ¶ 9433 (D. Mass. 1952).[return to text]

  29. See Rev. Rul. 67-415, 1967-2 C.B. 383. However, where property is acquired in a foreclosure sale, the transfer tax should be based on the purchase price paid at the foreclosure sale, plus costs, without regard to the amount of indebtedness attached to the property and assumed by the purchaser. See Brown, supra (applying former Treas. Reg. § 47.4361-2(a)(4) relating to foreclosure sales).[return to text]

  30. Id.[return to text]

  31. Based on Rev. Rul. 67-415.[return to text]

  32. California courts have not expressly applied the step transaction to the transfer tax. However, the step transaction doctrine has been applied in a number of California property tax cases. See, e.g., McMillin-BCED/Miramar Ranch North v. County of San Diego, 31 Cal. App. 4th 545 (1995); Shuwa Investments Corp. v. County of Los Angeles, 1 Cal. App. 4th 1635 (1991).[return to text]

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