Reporting the sales price on a transaction for a real estate excise tax affidavit or refund petition can be tricky in the State of Washington, depending which side of the coin you’re on.
Seattle's hot real estate market presents two special tax-saving opportunities – or, for the unwary, two tax traps – involving Washington State's real estate excise tax.
The first arises when above-market rents in place at a property contribute to its selling price. The second occurs when the sale of a property experiences high vacancy. In both scenarios, some buyers and sellers report prices that are higher than they should be for the real estate excise tax. At nearly 1.8 percent of the property's sale price, real estate excise tax is a sizable trans-action cost that deserves attention.
Skewed By High Rents
With above-market rents, a portion of the sale price may reflect the value of contracts and business efforts. The tax only applies to the consideration paid for real estate, so the consideration paid for above-market contracts should be separated out as nontax-able.
Although we believe Washington law is clear on this, the Department of Revenue has been struggling to determine its position. The department recently agreed taxable value excludes the portion of the purchase price attributable to above-market rents, but then it changed its position.
Since these vacillations occur in the context of individual taxpayer cases, other taxpayers do not necessarily know what the department's position is at any given time. The department has not published any rules or guidance specific to this scenario.
Impaired By Vacancy
In the scenario involving the sale of a property with high vacancy, the buyer and seller frequently agree on a price as though occupancy were full and then deduct an amount for the vacancy shortfall. The deduction reflects the costs to lease the remaining space, and also the entrepreneurial profit the buyer requires for undertaking the risk and work required to achieve full occupancy.
Some parties to a transaction mistakenly report the stabilized value instead of the amount actually paid for the property. The only price they should report for tax purposes is the sum after deducting for vacancy, as that represents the actual amount paid.
Both parties have an incentive to ascertain and report the correct price on the real estate excise tax affidavit. Though the parties can negotiate who pays the tax, the seller is responsible for its payment by law. And yet, the Department of Revenue can enforce payment by placing a lien against the property, making the buyer indirectly liable.
Both buyer and seller sign the affidavit reporting the sales price, under penalty of perjury. Buyers may feel the ongoing effect of the reported price in the form of property taxes, since county assessors pay attention to the affidavits in determining property tax values. With this in mind, both parties should care about correctly reporting the transaction.
Buyers and sellers in either scenario can put themselves in a favorable tax position by presenting the information about the transaction carefully, whether in the affidavit or in a refund petition to the Department of Revenue. Note that a refund petition, if applicable, must be filed within four years of the transaction date.
Information about the transaction should be presented to the taxing authorities in a clear manner to establish the correct facts and legal analysis. In the first scenario, a detailed explanation of the facts ideally includes an appraisal that excludes the price paid for the value of the above- market leases in place, as opposed to the real property.
In reviewing the transaction, the Department of Revenue should presume the price paid is taxable, but the taxpayer can rebut that position. When the transaction price reflects more than the price for real estate alone, the department often next turns to the property's assessed value instead.
The taxpayer can argue that, by law, an appraisal as of the sale date trumps the assessed value as evidence of the taxable amount. For this reason, an appraisal is important for the above-market rent scenario.
In the high-vacancy scenario, however, the presumption applies that the price paid is taxable, and no appraisal should be needed. Therefore, the parties should report the actual price paid after accounting for the vacancy shortfall.
Recent experience indicates the Department of Revenue may choose to challenge an affidavit or deny a refund claim if it takes the position that the portion of the price attributable to above-market rent is untaxable. That does not mean the department is right, however, and its vacillations suggest its directors feel uncertain about their position. Taxpayers with strong facts should pursue the issue and work diligently to make a strong case that will help the department get to the right result.
Whether a sale involves the added value of contracts or a deduction for high vacancy, seeking professional advice about how to best report the transaction on the real estate excise tax affidavit, or in a refund petition, can turn the sale into a significant tax opportunity.