In order to avoid problems at the recorder's office, all assignments of leases which are to be submitted for recording in California must state explicitly on the front page of the document whether or not the remaining term of the lease exceeds thirty-five years, and, if so, that such assignment is subject to transfer tax. Any assignment of ground lease that is subject to transfer tax should also state on its face the consideration to be paid for such assignment, which consideration must be the reasonable fair market value of the ground lease.

The fair market value listed on any assignment of ground lease should be the value of the ground lease alone, excluding any property which the ground lease is transferred alongside. Transfers of ground leases are common within the context of a larger sale, for example in the context of the sale of a mall made up of a fee interest which is burdened by one or more so-called “sandwich” ground leases. In these situations, the parties must allocate the overall purchase price among the fee and leasehold interests. Without an allocation, the parties risk being taxed twice for the same interest, as the assessor calculates the transfer tax due based on the purchase price stated on the transfer document.

PALO ALTO, CA—Documentary transfer taxes collected on the transfer of real property interests are a major source of revenue for counties and municipalities in California. So says locally based Michael Polentz, chair of the real estate and land use practice group at Manatt, Phelps & Phillips LLP. He, along with Elizabeth Levin, an associate in the same group in the Los Angeles office, say in this exclusive commentary that “as local governments endeavor to refill their coffers, depleted in the wake of the recession, many have taken a closer look at the tax potential of a broad spectrum of real property conveyances beyond the classic transfer of a deed.”

The views expressed in the commentary below are the author's own.

Assignments of long-term leases (often called “ground leases”), in particular, have fallen under the assessor's microscope. County recorder's offices across the state are paying close attention to lease assignments and may reject those which do not properly state the tax to be collected thereon.

The California Documentary Transfer Tax Act (the “Act”) confers authority to counties and cities to collect transfer tax on a broad spectrum of conveyances, including joint tenancy interests, remainder interests, life estates, non-temporary easements, and even the transfer of title on mobile homes installed on permanent foundations. Though the transfer of any interest in a lease is, strictly speaking, a transfer of a real property interest and within the purview of the Act, a 1989 case, Thrifty Court v. County of Los Angeles, limited the application of the Act to only those leases with terms of thirty-five years or more. The thirty-five year threshold is calculated as of the time of the transfer, and includes both the initial lease term and any renewals thereof. Thus, a twenty-year lease with two ten-year options to renew would be taxable if transferred in its third year (as the remaining term is 37 years), but would not be taxable if transferred in its sixth year (as the remaining term is 34 years). Some counties and municipalities however have stipulated a higher threshold than the state-wide minimum of thirty-five years, and transferors of leases should therefore confirm the threshold with legal counsel prior to any transfer.

In order to avoid problems at the recorder's office, all assignments of leases which are to be submitted for recording in California must state explicitly on the front page of the document whether or not the remaining term of the lease exceeds thirty-five years, and, if so, that such assignment is subject to transfer tax. Any assignment of ground lease that is subject to transfer tax should also state on its face the consideration to be paid for such assignment, which consideration must be the reasonable fair market value of the ground lease.

The fair market value listed on any assignment of ground lease should be the value of the ground lease alone, excluding any property which the ground lease is transferred alongside. Transfers of ground leases are common within the context of a larger sale, for example in the context of the sale of a mall made up of a fee interest which is burdened by one or more so-called “sandwich” ground leases. In these situations, the parties must allocate the overall purchase price among the fee and leasehold interests. Without an allocation, the parties risk being taxed twice for the same interest, as the assessor calculates the transfer tax due based on the purchase price stated on the transfer document.