By Grace Winters and Jordan Tessier of Manatt, Phelps & Phillips, LLP
The entity sale has long been a popular vehicle to indirectly transfer real property in California. However, the California Supreme Court recently changed the economics of such a transfer, deciding that such transfers can be subject to a county-imposed tax known as a “documentary transfer tax.” Although the documentary transfer tax was always a cost to be considered in a direct transfer of real property, buyers, sellers and investors will now need to factor the documentary transfer tax into their pricing for entity transfers.
Under California law, a county may impose a documentary transfer tax equal to $0.55 for every $500 (or a fraction thereof) of consideration paid on each “deed, instrument, or writing” transferring an interest in land. Payment of the documentary transfer tax is a common feature of California real estate transactions and is generally applicable in any direct transfer of real estate. As such, buyers and sellers typically allocate responsibility to pay the documentary transfer tax in their negotiation of the deal terms and document that responsibility in the purchase contract. However, a recent California Supreme Court ruling has expanded the scope of transactions that will trigger documentary transfer tax liability to include entity transfers.
In 926 North Ardmore Avenue, LLC v. County of Los Angeles, the California Supreme Court analyzed whether a transfer of interests in a property-owning entity triggered documentary transfer tax liability. In Ardmore, an individual holding the sole interest in the entity that owned a multifamily property transferred a portion of its interest in the entity rather than directly transferring title to the multifamily property. Initially, the county did not impose a documentary transfer tax on the transaction. However, the Los Angeles County Assessor later sent a notice to the property owner demanding payment of the county’s documentary transfer tax and the property owner challenged the imposition of the tax. The property owner argued that the tax should not apply because the law imposing the tax is restricted to instruments that directly reference real property, not instruments transferring entity interests. However, the Court ruled that the instrument was taxable and subject to documentary transfer tax even though the instrument only transferred the property owner’s interest in the entity on its face and did not reference the multifamily property. According to the Court, “the critical factor in determining whether the documentary transfer tax may be imposed is whether there was a sale that resulted in a transfer of beneficial ownership of real property.” In this case, because the property owner transferred more than 50 percent of its interest in the entity that owned the multifamily property, a change in ownership had occurred under California law. Although the change in ownership was not evidenced by a deed or other instrument that explicitly transferred ownership in the real property, the Court ruled that the transfer was still subject to documentary transfer tax.
The Court’s ruling in Ardmore clarifies the realm of transactions and instruments that will trigger a documentary transfer tax in California. Now it is clearly permissible for a county to impose a documentary transfer tax on an instrument that (i) conveys for consideration an interest in a legal entity that owns real property and (ii) results in a change in ownership of the property under California law. Buyers, sellers and investors must now take a closer look when evaluating the acquisition of an interest in a legal entity that owns real estate, as the transaction may be subject to an additional tax liability.
Grace Winters is a partner in the Real Estate & Land Use Practice Group at Manatt, Phelps & Phillips, LLP, located in the Orange County office. Jordan Tessier is an associate in the Real Estate & Land Use Practice Group at Manatt, Phelps & Phillips, LLP, located in the Orange County office.
 Rev. & Tax. Code, § 11911.
 926 North Ardmore Avenue, LLC v. County of Los Angeles (2017) 3 Cal.5th 319, 325–26.
 Id. at 337.
 See Rev. & Tax. Code, § 64(c)(1).
 See Rev. & Tax. Code, § 64(c) and (d).