Compliance Key for Real Estate Tax Issues

Michele Randall, director in the tax department with Deloitte, sat down with REIT.com following her session on state and local tax issues at REITWise 2012: NAREIT's Law, Accounting and Finance Conference in Hollywood, FL. last month.

Randall began the interview by discussing transfer taxes, which she said can be a significant part of any transaction. She added that 39 states currently have a transfer tax.

"When you have an asset sale and you record a deed you pay a transfer tax," Randall said. "If you transfer an entity, not all states have a transfer tax so there can be a large amount of difference in the amount of tax that you pay depending on how the deal is structured."

Randall said because state budgets are extremely tight, states are trying to find ways to expand the tax base—and controlling interest transfer taxes are part of that. She said 16 states have a controlling interest transfer tax currently, most recently one was enacted in Michigan.

"We expect this trend to continue, and one thing to understand about transfer taxes and controlling interest transfer taxes is that the rules vary greatly by state," she said.

From a state perspective, companies that operate as an UPREIT are subject to certain compliance issues and some states differ from the federal rules in this regard, Randall said.

One of the biggest issues, she said, are states that have focused on imposing tax on non-resident partners in partnerships.

"Five to 10 years ago, there were about 20 states that had a withholding tax," she said. "Now there are about 40 states that have a withholding tax, which increases the compliance burden."

Randall said the bigger issue is that states don't necessarily follow the flow-through treatment of a partnership or of a REIT, so you may have entity-level taxes at the state level but you need to consider how that impacts your overall operating cost from a tax perspective.

Regarding sales tax issues at the state and local level, Randall said some jurisdictions do have sales tax on rental income. She said it is important for companies to stay on top of the compliance to make sure you are collecting these taxes appropriately on the right tax base.

"What we are seeing from a state perspective is an uptick in audits. Five to 10 years ago, I didn't see much in the way of sales tax audits in the real estate industry," Randall said. "Lately it's becoming an increasing activity from states."

She added that real estate companies also need to be mindful of the use tax when purchasing out of state.