In 2019, the Washington Legislature substantially revised and increased the tax on transferring real property with its real estate excise tax (REET). As of January 1, 2020, a new tiered rate applies at the state level of the tax, and the amount of tax could be almost double, depending on how valuable the property is.
Family businesses often lease their office space or manufacturing facilities from family members and are therefore especially impacted by changes in holdings to real property. This advisory examines how family members in Washington State hold real property and how that impacts their REET exposure.
While in prior years there was a uniform state tax rate of 1.28 percent of the value of real property triggered by either (1) the sale of real property or (2) the transfer of a controlling interest (50 percent or more) in an entity that owns Washington real property, beginning January 1, 2020, the state rate will be imposed at different tiers, as follows:
- 1.1 percent of the selling price up to $500,000;
- 1.28 percent of the selling price above $500,000 and up to $1,500,000;
- 2.75 percent of the selling price above $1,500,000 and up to $3,000,000; and
- 3.0 percent of the selling price above $3,000,000.1
After January 1, 2020, the combined rate for many properties could be as high as 3.50 percent for the portion of the value over $3,000,000 after local rates, typically 0.25 percent or 0.50 percent, are added.
Revenue Department Granted Authority to Ignore Transaction Forms
The Legislature saw that this new, tiered rate structure would induce some property owners to stage or structure transactions to take advantage of the lower tiers. So it gave the Department of Revenue a new power to ignore the form of a transaction if it appears that the structure was designed to avoid tax and had no other, non-tax rationales.
How does this affect the question whether married couples should hold real property as separate interests or as community property?
REET applies to the sale of an interest in real property. A married couple who holds real property as community property is viewed as a single seller, so the value of the property they sell will be taxed as a unit under the graduated rates listed above.
But interests held by co-owners as tenants-in-common are viewed as separate interests in the real property, and the sale of each is subject to REET separately. So, if a married couple had acquired real property before 2020 as tenants-in-common rather than as a unit, the sale of their tenant-in-common interests in 2020 or later should be valued separately under the tiered rates.
Considerations for How to Hold Property Go Beyond REET
It seems likely that if a couple holds real property in their community today, and they execute separate property agreements to create a tenancy-in-common right before selling the property, the Department of Revenue might have good grounds to disregard the separate property agreements and tax the transactions as if they were a single sale.
But, thinking longer term, there may be reasons to hold real property as tenants-in-common other than a potential savings in REET on the eventual sale.
There is a difference in protection from the creditors of one spouse, for example. And the couple may have differences in perspective on how to allocate the property in their estates or via gifts. As time lengthens, these non-REET reasons for holding real estate as separate property in a tenancy-in-common may well be sufficient to defeat the Department of Revenue’s impulse to collapse the sale of the two interests.
Because REET applies to the sale of a controlling interest in realty-holding entities, the same considerations may apply to how couples hold interests in a family investment vehicle, for example. But, because the tax is imposed on 100 percent of the value of the property when 50 percent of the entity’s interests are sold, the calculation of possible impact is more complicated.
REET, of course, is not the only factor in structuring how you own real property, but the Legislature has introduced a new factor for consideration.