Now May Be the Time to Sell as Real Estate Excise Taxes Rise
In the 2019 legislative session, the Washington Legislature passed, and the Governor signed, a bill that makes substantial changes to how taxes on the sale of real property in Washington (called the real estate excise tax, or REET) are calculated and extends the lookback period for controlling interest transfers. Under the new law, many property owners will see substantially increased taxes on the sales of real estate and interests in property-owning businesses.
New Graduated Tax Rates
Washington State REET is currently at a rate of 1.28%, plus local taxes up to an additional 50 basis points. Under the new law, the REET is decreased for properties sold for less than $500,000 and increased for those sold for more than $1,500,000. And the new rates are marginal, meaning that each portion of the sales price is taxed on a graduated basis. The new marginal rates are:
- Under $500,000 – 1.10%
- $500,001 to $1,500,000 – 1.28%
- $1,500,001 to $3,000,000 – 2.75%
- Greater than $3,000,000 – 3.00%
Homeowners and commercial property owners with properties worth more than $1,500,000 will see a hefty tax hike. Remember, local tax rates are still included on top of the state’s marginal rates, meaning that a property in Seattle selling for more than $3,000,000 will be subject to a 3.5% marginal excise tax, which is nearly double the 1.78% tax rate that currently applies. Although the tax rate is marginal, the numbers can add up fast. The sale of a $2,500,000 property, for example, would see a tax increase of nearly $14,000. On a $10,000,000 property, the state’s portion of the sale would more than double from $128,000 to close to $270,000.
For most residential property owners, however, this amounts to a tax cut. Because it is a marginal rate, the first $500,000 will always be taxed at 1.1%, or 0.18% less than before. That means that sellers of properties worth less than $1,500,000 (the vast majority of residential property owners in the state) will see their real estate excise tax fall by as much as $900 at the state level.
It’s important to note, however, that timberland and agricultural land are all exempt from the new marginal rates. Their REET burden remains fixed at 1.28% at the state level. Anticipating that sellers will seek to classify properties under these categories to take advantage of the lower rates, the statute specifies that property must be classified by its predominant use, which the legislature has directed the Department of Revenue to define in regulations. And even if the rate does not affect your properties now, it may affect them in the future; the state will adjust the marginal thresholds every four years to match inflation.
Controlling Interest Lookback Period Extended
Currently, REET is triggered when a controlling interest (50% or more) in an entity owning real property is transferred to another party within a 12-month period. That is, if one owner sells a 25% interest on January 1 and another owner sells a 25% interest on December 31 of the same year, and the parties were acting in concert in connection with a related transaction, then REET is triggered as to both sales on December 31. Under the new law, however, the lookback period for controlling interest transfers is extended to 36 months. Under the earlier example, the REET would be triggered if the second sale occurred as late as December 31 almost three years later.
Anticipating that business owners would try to structure transactions to avoid paying the REET, the Legislature directed the Department of Revenue to disregard the form of the transaction or series of transactions and look to the substance of the overall deal to determine REET liability. We will be closely tracking the Department’s rulemaking on this subject and providing input on the process.
More importantly, the extended lookback period is likely to cause surprise, conflict and liability in businesses owning real property. If a business owner holding a 25% interest sells in January and justifiably expects not to pay REET on the sale, but another owner later decides to sell her own 25% interest 34 months later, then the first owner will be hit with tax liability and may not even know about it.
Even if there is no REET required on the sale of a business interest, the new law may require reporting. Any transfer of one-sixth or more (16.67%) of a property-owning entity triggers a reporting requirement. If the report isn’t filed and REET is ultimately triggered, then the entity is liable for the REET plus a 50% evasion penalty.
The new tax rates go into effect on January 1, 2020, so it may be time to discuss them with your real estate and tax professionals to determine how this will affect your properties and your businesses. If you have been considering a sale, now might be the time. If you are considering selling less than a 50% interest in a business entity that owns real property, consult with attorneys at Stokes Lawrence to ensure that you are protected in the event that a future REET event occurs.