Points of Practice
Putting a Stop
to the “Drop and Swap”? Commercial Real Estate Loophole May Soon Close by ADAM R. Todd Selling real estate through a limited liability company currently has advantages. However, due to contemplated legislation in Ohio, the so-called “LLC Loophole” may soon close. When a county auditor accepts a conveyance statement for an arms-length sale of real property, it reassesses the property’s taxable value based upon the sale price. This typically results in increased property taxes. Ohio law also permits county auditors to charge conveyance fees on non-exempt real estate transfers. An Ohio county may charge up to $4.00 per $1,000 of the sale price. In high-dollar transactions, conveyance fees may be substantial. Ohio real estate investors discovered that using an LLC as an intermediary to transfer property allows them to avoid both: 1. An increase in property taxes due to reassessments based upon the sale price; and 2. Paying conveyance fees.
Here is how the LLC Loophole works. When a property owner transfers real property to an LLC he owns as a capital contribution and there is no exchange of money, the transfer may be exempt.1 The auditor does not collect a conveyance fee and there is no sale price on which to base a reassessment. With the above in mind, consider this example. John and Susan enter into a real estate purchase contract and agree that Susan will pay John $1 million to purchase John’s real property known as Blackacre. John forms a new LLC he calls Blackacre, LLC (a new entity ensures there are no existing liabilities, liens, judgments, etc.). John transfers Blackacre to Blackacre, LLC as a capital contribution. In other words, the property serves as his investment to provide value to the LLC. The transfer is exempt from the conveyance fee as John owns all of the membership interest in Blackacre LLC. The county auditor does not reassess the property’s tax value because no “sale” occurred. At the closing of John and Susan’s transaction, Susan pays John $1 million and John transfers all the membership interest in Blackacre, LLC to Susan. Susan now owns Blackacre through Blackacre, LLC. Many in the central Ohio area refer to the abovedescribed transaction as a “drop and swap.” (To most tax professionals, the term “drop and swap” actually refers to a 1031 exchange mechanism, where a real estate interest goes from an LLC or corporation to an individual and the individual trades that interest to avoid capital gains tax.) No matter how the transactions are labeled, they have cost Ohio counties countless dollars in lost conveyance fees and especially increased assessments. County auditors, school boards and other property tax funded organizations are keenly aware of the issue.
24 | Columbus Bar L aw yers Quarterly Winter 2019