In 926 North Ardmore Avenue, LLC v. County of Los Angeles, the California Court of Appeal Second District recently held that a change in the ownership of an entity that indirectly owns real property through another entity constitutes a "change of ownership" of the real property itself, triggering the imposition of documentary transfer tax (DTT) under the California Revenue and Taxation Code (RTC) (229 Cal. App. 4th 1335 (2014)).

Brothers Bruce and Allen Averbrook were trustees of a family trust that collectively owned an apartment building at 926 North Ardmore Avenue. In 2008, the Averbrooks, acting in their capacity as trustees, established a limited liability company (LLC) to hold the apartment building. The family trust conveyed the apartment building to the LLC and subsequently transferred its interest in the LLC to a limited liability partnership (LLP) owned by the trust.

Through a series of transactions in 2008 and 2009, the Averbrooks transferred approximately 90% of their interest in the LLP from the family trust to separate irrevocable trusts in their name. The LLC properly reported this transfer through a "statement of change in ownership of legal entities" pursuant to the RTC.

In 2011, the Registrar-Recorder for the County of Los Angeles demanded that the LLC pay a documentary transfer tax based on the value of the apartment building. The Recorder asserted that the tax was due pursuant to California Revenue and Tax Code Section 11911 and Los Angeles County Code Section 4.60.020, which permit the imposition of a tax on "each deed, instrument or writing by which any lands, tenements or other realty sold within the county of Los Angeles shall be granted, assigned, transferred or otherwise conveyed to or vested in the purchaser or purchasers." The Recorder claimed that the 2008 and 2009 transfers of the limited partnership interests constituted a change in the ownership of the LLP triggering DTT.

The LLC paid the tax and then filed a suit seeking a refund. The LLC argued that the transfer of the ownership of the LLP was not a taxable event because:

The Superior Court rejected this argument and the LLC filed an appeal with the California Court of Appeal Second District.

The court affirmed the Superior Court's judgment upholding the County's imposition of the tax. The court held that the term "realty sold" in the RTC and Los Angeles County Code applies when a transfer of interest in a legal entity results in a change of ownership or when more than 50% of an entity is transferred within a 12-month period.

The analysis focused on the history of the statutes and legislative intent that documentary transfer tax applies when there has been a sale that results in the transfer of realty. The interpretation of the term "realty sold" to include changes in the ownership of legal entities directly or indirectly owning real property is consistent with that intent by capturing most forms of legal entity transfers resulting in a change in the beneficial ownership of the property. The court held that even though the LLP did not own the property directly, but rather owned another entity that held title to the property, there was a change in the beneficial ownership of the property. Furthermore, the court reasoned that if the statute was interpreted as the LLC suggested, it would effectively allow property owners to avoid the transfer tax by conveying their real property to a wholly owned subsidiary established for the sole purpose of holding the property, and then selling the subsidiary instead of the real property itself.

As a result, the court found that because the transfer of a 90% interest in the LLP resulted in a change of ownership, there was realty sold, though indirectly, and the imposition of the transfer tax was proper.

This decision is important because it redefines the tax liability that results from a change of ownership of an entity that does not directly own real property, but rather owns another legal entity that owns real property.

Counsel should consider this case when advising clients on structuring deals and transferring real property in California. The court's decision: