Transfer Taxes and the Importance of Identifying the Value of the Real Estate Only
Underwriting real property and transfer taxes for commercial real estate deals in Washington, D.C. has never been an easy task, and the implications for getting these inputs wrong have never been more severe. The recent changes to the real estate transfer tax rate accelerated the pace of deals with many buyers and sellers rushing to the finish line to close by October 1, 2019. On that date, the transfer tax rate increased from 2.9 to 5% for Class 2 (Commercial and Mixed-Use) Property. This has had a chilling effect on investment in the District. Acquisition Price Allocation (APA) studies are becoming increasingly important to ensure that transfer taxes are not paid on an inflated amount—even for properties that wouldn’t traditionally be thought of as having non-realty components imbedded in the consideration. For example, if a sale includes a significant amount of tenant improvements supplied by the seller and paid for (at least in part) by the buyer, these costs should likely be removed before reporting the value of the real property on Form FP-7. Other situations that could warrant special review include properties with substantial furniture, fixtures, and equipment (FF&E), bulk transactions, related-party sales, and purchases by foreign investors. The good news is that buyers and sellers do have some recourse in the event they have overpaid transfer taxes at closing, although the courts have indicated that the window to request a refund on these taxes is two years. Ryan can assist in recovering the overpayment of transfer and recordation taxes.
New Owner Appeals
As the Office of Tax and Revenue (OTR) continues to turn a blind eye to the impact of lease-up costs and tenant rollover, current assessments are increasingly greater than market sales prices. New owners in the District can appeal the value of their current assessment (provided they close before October 1 of that tax year). For example, if an owner closes as of September 1, 2020, they can file an administrative appeal of the Tax Year 2021 Valuation (value date January 1, 2020). If the owner closes after October 1, the owner must wait until the new assessment is issued in February of the subsequent year to appeal the value (or tax class).
Recently, the District has begun enforcing DC Code 47-825.01a, which states that a new owner can only appeal an assessment and/or tax class if the prior owner did not appeal by April 1. This has further complicated issues for new owners and underlines the importance of obtaining sound advice prior to closing. Buyers must check with the seller as part of their due diligence if there is a pending appeal. That appeal, if active, can be assigned to the new owner—a process that Ryan navigates on behalf of its clients.
DC Tax Year 2021 Assessment Appeals
If history is any guide, owners should anticipate more increases in their assessed values for the coming tax year. Proposed assessments for Tax Year 2021 will be mailed by March 1 and must be appealed by April 1, 2020. Property owners should take extra care in appealing any properties that are incorrectly classified as commercial, vacant, or blighted. Ryan can assist in navigating this convoluted appeal process and securing exemptions from Class 3 and 4 designations. The District also requires filing of Income & Expense and Rent Rolls for all properties on this list. There is a 10% penalty on the next year’s tax bill if the form is not completed and returned by April 15. Ryan can review these forms to ensure compliance with the requirements.
New Construction Supplemental Assessments
Developers of commercial real estate in the city often find that they have drastically underestimated the amount of real property tax due over the course of development. It’s no wonder given the city’s complex system of new construction supplemental assessments, which can be issued two times per year (as of June 30 and again as of December 31). The Mayor, pursuant to DC Code, issues these Supplemental Values once a project reaches 65% completion (and more than $100,000 in value is created—an easy threshold to surpass). The OTR, which is understaffed, often fails to capture the value of new construction in a timely fashion. There is no statute of limitations on how far it can go back to issue these Supplemental Notices of Value. These supplemental value notices are sent to the address on file with the District (sometimes the construction office or to someone in accounting at a corporate headquarters). These notices must be appealed within 45 days, or they become final. Developers must therefore instruct their teams to be on the lookout for these mailings.