New York State Realty Transfer Tax:
Transfers to a Grantor Retained Annuity Trust

By John W. Halloran, CPA

Grantor retained annuity trusts (GRATs), are commonly considered during the estate planning process. Their purpose is to allow for transfers of property by gift at discounted values. The discount applies because the grantor retains an economic interest in the property in the form of an annuity interest, the annuity being payable for a stated number of years. The discount applies because the donor is not transferring 100% of the value of the property to the trust. Consequently, GRATs are often used to remove assets that are likely to appreciate in value from an individual’s estate. In doing so, the appreciation avoids being subject to estate taxes. Today, real estate transfer taxes are imposed by many states and municipalities. These taxes are computed based upon the consideration or value of the real estate and could be significant. Certain estate planning techniques utilizing GRATs, as well as contemplated transfers of real property, should include an analysis of these taxes and the exemptions afforded under state and local laws.

New York State Tax Law provides for an exemption to the extent that a transfer effectuates a mere change of identity or form of ownership or organization where there is no change in beneficial ownership. In prior advisory opinions issued by the State on this exemption, the analysis generally compares the rights from a beneficial ownership perspective before and after the change to arrive at a conclusion. The ownership interest in a corporation, partnership, or trust that itself owns an economic interest in real property always will be an economic interest in real property [New York Reg. 575.6].

The New York State Department of Taxation and Finance recently issued an advisory opinion on the applicability of the exemption from transfer tax upon the transfer to a GRAT of a 99% limited partnership interest owning a controlling interest in an entity owning real property. The opinion also addressed the subsequent conveyance from the GRAT to the beneficial owners via a discretionary trust.

The facts presented in the advisory opinion are as follows:

1. The grantor is a 99% limited partner.
2. The general partner of the limited partnership is a corporation owned by the grantor.
3. The limited partnership owns only one asset, commercial real property located in the City of New York. The fair market value of the real property is $51 million, which is subject to mortgages of approximately $41 million.
4. The grantor is considering transferring the entire limited partnership interest to an irrevocable GRAT.
5. The limited partnership interest is the only asset being transferred.
6. Under the terms of the GRAT, it will pay to the grantor an annuity payment of approximately $2 million (20% of the net value of the real property) per year for a term of seven years.
7. The annuity will be paid from income derived from the GRAT, and, should that income be insufficient in any year, from the GRAT principal.
8. If the GRAT income exceeds the amount of the annuity, the excess income will be added to trust principal.
9. The GRAT further provides that after a term of seven years (or upon the death of grantor, whichever is earlier) payment of the annuity will cease, the GRAT will terminate, and the GRAT principal will be transferred to a discretionary trust for the benefit of the grantor’s spouse and children.
10. The grantor will be making a taxable gift equal to the difference between the net value of the assets transferred to the GRAT ($10,000,000) and the present value of the annuity stream retained, which has been computed to be $9,927,392.
11. During the term of the trust, the grantor would be deemed to be the owner of the trust and would be taxed on all income of the GRAT for federal tax purposes.
12. 100% of the GRAT principal would be included in the gross estate were the person to die during the trust term.

Conclusion:

The Department reasoned that after the conveyance to the GRAT, the grantor’s interest in the real property will be comparable to that of a seller of an interest in real property who takes back a seven-year purchase money note in the approximate amount of $10 million. Therefore, the Department concluded that the exemption does not apply to any part of the conveyance to the GRAT and that the transfer would be subject to the transfer tax to the full extent of the consideration, computed at $51 million times 99%, or $50.49 million.

In applying the same line of reasoning, the Department concluded that the grantor’s spouse and children would be the beneficial owners of the limited partnership interest held by the GRAT and will continue to be the beneficial owners of this interest after it is conveyed by the GRAT to the discretionary trust. Therefore, the conveyance of the limited partnership interest from the GRAT to the discretionary trust, upon termination of the GRAT, will be exempt from any additional transfer tax under the change of identity or form of ownership exemption.

The New York City Department of Finance issued a similar opinion based upon the same fact pattern in holding the New York City transfer tax applicable.

Alternate Considerations:

New York State previously issued an advisory opinion on the applicability of the exemption from transfer tax on the transfer of real estate into a revocable trust. Under the trust agreement all the rights were retained to use and all income inured to the benefit of the grantor. In addition, the grantor retained the unconditional right to revoke the Revocable Trust. Accordingly, the exemption applied. This type of transfer is very common to avoid the cost of probating the assets of an estate. It should be noted that there is also an exemption from transfer tax afforded conveyances of real property without consideration, provided it is not a sale, including conveyances of realty as bona fide gifts. A technique commonly used by estate planners today includes the transfer of real property to a limited liability company (LLC) followed by the outright gifts of member interests to family members. There are various methods available to transfer real estate for estate planning purposes. In view of real estate transfer tax implications using a GRAT, other methods of transfer should also be considered.

John W. Halloran, CPA, is a Senior Tax Manager in the New York office of PKF, Certified Public Accountants a Professional Corporation. Mr. Halloran holds an MBA in Taxation from St. John’s University and is currently a member of the Partnership Committee of the New York State Society of Certified Public Accountants (NYSSCPA) as well as a member of the American Institute of Certified Public Accountants (AICPA).

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