By Dmitrii Gabrielov and Tim Gustafson

The New York State Supreme Court, Appellate Division, affirmed the New York City Tax Appeals Tribunal’s (Tribunal) determination that certain real estate transactions were subject to the New York City Real Property Transfer Tax (RPTT) under the step transaction doctrine.

The taxpayer and a nonparty owned, respectively, 45% and 55% tenant-in-common interests in New York City real estate. They contributed their tenant-in-common interests to a newly formed LLC in exchange for 45% and 55% LLC membership interests, respectively. On the same day, the taxpayer transferred its 45% LLC membership interest to the nonparty in exchange for cash and debt relief.

In the Tribunal proceeding, the taxpayer argued that the contribution of the 45% tenant-in-common interest to the LLC was exempt from RPTT as a “mere change of form of ownership” and the transfer of the 45% LLC membership interest was exempt as a transfer of a noncontrolling interest in an entity that owns real property. However, the Tribunal applied the step transaction doctrine to characterize these transactions as a taxable transfer of the 45% tenant-in-common interest in exchange for cash and debt relief. The Tribunal found that the contribution agreement contained provisions more typical of a sale than the formation of a joint venture. The Tribunal noted, in part, that the taxpayer was released under its obligations under the mortgage on the property and received back its collateral while the nonparty was not released and had to provide a replacement letter of credit. The nonparty’s obligation to close also was conditioned on the LLC’s interest in the property being insured while the taxpayer’s obligation to close was not.

The Appellate Division affirmed the Tribunal’s application of the step transaction doctrine. The Appellate Division also held that even if the step transaction did not apply, the taxpayer’s contribution to the LLC did not constitute a “mere change of form of ownership” because the taxpayer no longer held a 45% direct or indirect interest in the real property at the conclusion of the same-day transactions. GKK 2 Herald LLC v. N.Y.C. Tax App. Trib., No. 82/16 4074 (N.Y. App. Div., 1st Dep’t Oct. 10, 2017).