Requiem for the Drop and Swap . . . Not Just Yet!
By Drew Emmert, DBL Law
For many years, seasoned commercial real estate (CRE) investors in Ohio have structured real estate transactions as an entity purchase and sale, often referred to as a “drop-and-swap”. In a drop-and-swap, the seller transfers or “drops” the real property into a newly formed, single-member, limited liability company, usually formed by the seller, in a conveyance that is exempt from Ohio conveyance tax. The seller then transfers 100% of the membership interests in the LLC to the buyer in exchange for the purchase price.
Such a structure has a two-fold advantage. First, the transaction avoids the payment of a conveyance tax at the time that the deed is recorded, which is usually a seller obligation, and therefore a seller incentive. Secondly, and most importantly, the structure lessens the chance that the county auditor will increase the property’s tax valuation for real property tax purposes, which is a significant motivator for the buyer.
Since county real estate taxes are paid annually, not just once at the time of a sale, a reduced tax valuation is a huge motivator to CRE purchasers because real estate taxes are a recurring yearly obligation.
At times, a sale of commercial real estate results in a gain that may be double or even triple the original tax-assessed valuation of a property. Such gains will typically cause real estate taxes to likewise double or triple in amount, since the county auditor will be notified of the increased sale price when the deed conveyance tax is collected, and the deed is recorded. If the transaction can be closed as a “drop and swap”, that is, without payment of a conveyance tax and no notice of the higher sale price to the county auditor, then the investor can avoid a significant increase in the property’s tax valuation and a commensurate real estate tax increase that the investor must pay annually.
CRE investors should definitely consider a drop-and-swap structure in the appropriate circumstances to:
- maintain a lower tax valuation of the subject property, and thereby,
- achieve significant tax savings.
However, there are many traps for the unwary when structuring a drop and swap or entity purchase that increase the likelihood that the transaction will be contested by the local BOE.
CRE investors should seek commercial real estate counsel experienced in successful entity purchase transactions and in fighting property tax complaints filed by the BOE. The advantages of a drop and swap may far outweigh the potential that the local BOE will file a complaint to increase the tax valuation of the subject property. Additionally, if the local BOE files a complaint to raise the tax valuation of the subject property, whether following an entity purchase or not, there are strategies to limit the BOE’s efforts.
Drew EmmertGGI member firm
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Dressman, Benzinger LaVelle psc (DBL Law) provides a complete range of services to meet legal needs in a wide variety of industries. With cross-industry collaboration, DBL Law attorneys offer comprehensive service on complex matters that transcend simple categorisation in many areas of law.
Drew Emmert is a Partner in DBL Law’s real estate, corporate, business and tax areas. He assists individuals, privately-held businesses, and real estate owners, investors, tenants, and developers, focusing on general business, real estate, construction, probate, estate planning, and intellectual property.
Published: Real Estate Newsletter, No. 14, Summer 2022 l Photo: SeanPavonePhoto - stock.adobe.com