A California Court of Appeal held that San Francisco may not impose a documentary transfer tax on the value of an existing 41-year leasehold interest upon the sale of the underlying property because the leasehold interest does not constitute “realty sold”. The taxpayer owned a commercial building and agreed to lease the ground floor to a separate business for 45 years. Upon recording the lease with the city and county of San Francisco, the taxpayer paid a real property transfer tax based on the value of the stream of rental payments due over the life of the lease. Six years later when the taxpayer sold the building, including the lease, it again paid the transfer tax and sought a refund for the amount paid based on the value of the payments due from the lessee during the remaining 41 years of the lease on the grounds the existing leasehold interest did not constitute “realty sold”.
The appellate court agreed with the taxpayer, holding that San Francisco cannot impose a documentary transfer tax on an existing leasehold interest with a remaining term of more than 35 years. Applying previous California decisions interpreting “realty sold”, the court looked to definitions of “change in ownership” as used in property tax provisions and found that a leasehold interest will be considered “realty sold” where there is a “creation of a leasehold interest in taxable real property for a term of 35 years or more.” Because the 41-year leasehold interest at issue was transferred, not created, the court concluded that the interest did not constitute “realty sold” and was not subject to the tax.