A partnership is transferring 100% of its partnership interests to a bank, in exchange for the bank cancelling debt and releasing guarantees -- but the partnership's underlying real estate is worth $10 million while the debt being cancelled is $15 million. For New York's Real Property Transfer Gains Tax, is the taxable 'consideration' the $15 million in cancelled debt, or the $10 million fair market value of the real estate?

Plain-English summary

This tax no longer exists. New York's Real Property Transfer Gains Tax (former Article 31-B of the Tax Law) was a 10% tax on the GAIN from transferring New York real property where consideration was $1 million or more. It was repealed for any transfer occurring on or after June 15, 1996. This 1992 opinion is preserved here for historical and research value, not as current law.

A partnership owned a leasehold interest in one commercial property and a fee interest in another, with a combined appraised fair market value of $10 million, plus a separate $50,000 cash account. Bank D had loaned the partnership $15 million years earlier, secured by a mortgage on both real estate interests; in a subsequent workout, the bank also got a security interest in the cash account, and the individual partners personally guaranteed part of the debt. To resolve the default, the partners agreed to transfer ALL of their partnership interests (a full, 100% controlling-interest transfer) to Bank D, in exchange for the bank cancelling the entire $15 million debt and releasing the partners' guarantees.

The petition asked what "consideration" should be used to calculate the gains tax on this controlling-interest transfer -- the $15 million in debt actually cancelled, or something else. The Department explained that controlling-interest transfers get their own special consideration rule, separate from ordinary asset sales: former Tax Law § 1440.1(c) requires apportioning the FAIR MARKET VALUE of the entity's real property interest to the percentage of the controlling interest being transferred, rather than looking at whatever price was actually paid or debt actually cancelled for the ownership stake. The Department's own regulation (former 20 NYCRR § 590.47) illustrates the point with a simple example: if a corporation's only asset is a $4 million property, transferring 100% of its stock makes the consideration $4 million (not whatever cash changed hands for the stock); transferring 50% makes it $2 million. And critically, fair market value for this purpose is GROSS value -- it is NOT reduced by any mortgage on the property. Applying that rule here, since 100% of the partnership interests transferred and the real property's fair market value was $10 million, the taxable consideration was $10 million -- even though the actual debt cancelled in the deal ($15 million) was considerably higher.

What this means for you

Lenders and borrowers restructuring debt through a controlling-interest transfer

Under this now-repealed tax, a distressed debt-for-equity swap involving a controlling interest in a real-estate-owning entity was taxed based on the underlying REAL ESTATE's fair market value, not the size of the debt cancelled or the price paid for the ownership stake -- which could cut the taxable consideration well below the actual economics of a workout, as it did here.

Real estate and workout attorneys structuring distressed partnership or corporate transfers

This opinion, together with the Department's own worked example in former 20 NYCRR § 590.47, is a clean confirmation that controlling-interest consideration is always driven by the entity's underlying real property's fair market value (apportioned by the percentage transferred), regardless of the entity's other assets, liabilities, or the transaction's actual price.

Accountants calculating gains-tax exposure on controlling-interest debt workouts

If you're reconstructing the gains-tax consideration for a historical controlling-interest transfer used to resolve distressed debt, this opinion is a direct authority that the calculation starts and ends with the real property's fair market value -- not the debt cancelled, and not reduced by any mortgage encumbering the property.

Common questions

Q: Does this controlling-interest consideration rule still matter today?
A: Not under this specific tax -- it was repealed for transfers on or after June 15, 1996. Current New York real estate and business transfer taxes have their own separate consideration rules for entity-interest transfers.

Q: Why was the taxable consideration LOWER than the actual debt cancelled?
A: Because the statute deliberately measures controlling-interest transfers by the underlying real property's fair market value, not by whatever price or debt relief the parties actually negotiated for the ownership interest -- a formula that can produce a lower (or higher) number than the deal's real economics, depending on the entity's financial situation.

Q: Would the mortgage on the property have reduced the $10 million fair market value used?
A: No -- the Department's regulation specifically confirms fair market value for this purpose is the GROSS value a willing buyer would pay a willing seller, not "net" fair market value after deducting mortgages.

Q: Can another lender or partnership in a similar debt workout rely on this exact ruling?
A: No, apart from the repeal -- an Advisory Opinion binds the Department only as to the petitioner and facts presented, though the underlying consideration formula (former § 1440.1(c) and former 20 NYCRR § 590.47) was a generally applicable rule during the tax's lifespan, not something unique to this partnership.

Citations and references

Statutes and regulations:

• former Tax Law § 1440.1(a) (general definition of consideration, including cancellation or discharge of indebtedness, for an ordinary transfer of real property)
• former Tax Law § 1440.1(c) (for a transfer of a controlling interest in an entity with an interest in real property, consideration is determined by apportioning the fair market value of the real property interest to the controlling interest transferred)
• former 20 NYCRR § 590.47(a) (the price paid for an ownership interest is generally NOT the consideration used to calculate gain on a controlling-interest transfer; consideration is the real property's fair market value apportioned to the percentage interest transferred, illustrated with a worked example)
• former 20 NYCRR § 590.47(b) (fair market value is generally determined by appraisal, as the amount a willing buyer would pay a willing seller; it is gross value, NOT reduced by mortgages on the property)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/real_prop_tran_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/real_property/a92_10r.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-92(10)-R
Real Property
Transfer Gains Tax
December 28, 1992

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. M921021B

On October 21, 1992, a Petition for Advisory Opinion was received from Andrew Feiner,
Esq. and William Korman, CPA, c/o Zellermayer, Gratch and Jacobs, P.C., 950 Third Avenue, New
York, New York 10022.
The issue raised by Petitioner, Andrew Feiner, Esq. and William Korman, CPA, is what is
the amount of consideration that should be allocated to real property upon the transfer of a
controlling interest in Petitioner's client to Bank D for purposes of the Real Property Transfer Gains
Tax (hereinafter the "gains tax").
Petitioner's client, a partnership, owns a leasehold interest in one commercial real estate site
and a fee interest in another. The leasehold and fee interest presently have a combined appraised fair
market value of $10 million, In addition, Petitioner's client has a cash bank account that contains
$50,000. Several years ago, Bank D loaned $15 million to Petitioner's client secured by a mortgage
on the leasehold and fee interests in real property. Approximately two years ago, as part of a
workout, Bank D received a further security interest in the cash account (by reason of lock-box
security interest in the rent derived from the real property). In addition, A, B and C, the partners of
Petitioner's client, personally guaranteed the interest and a portion of the principal of the bank debt
owed to Bank D. In exchange for cancellation of the debt to Bank D and for release of the partners'
guaranty of that debt, the partners will transfer all of their partnership interests in Petitioner's client
to Bank D.
Section 1440.1 of the Tax Law defines the term "consideration" for purposes of gains tax to
mean as follows:

1. (a) "Consideration" means the price paid or required to be paid for real
   property or any interest therein, less any customary brokerage fees related to the
   transfer if paid by the transferor, including payment for an option or contract to
   purchase or use real property. Consideration includes any price paid or required to
   be paid, whether expressed in a deed and whether paid or required to be paid by
   money, property, or any other thing of value and including the amount of any
   mortgage, purchase money mortgage, lien or other encumbrance, whether the
   underlying indebtedness is assumed or taken subject to. Consideration includes the
   cancellation or discharge of an indebtedness or obligation.
   (b) In the case of (i) the granting of an option with use and occupancy of real
   property or (ii) the creation of a leasehold or sublease that is a transfer of real
   property, as defined in subdivision seven of this section, consideration shall also
   include the value of the rental and other payments attributable to the use and
   occupancy of the real property or interest therein and the value of any option to
   purchase or renew included in such transfer.

-2­
TSB-A-92(10)-R
Real Property
Transfer Gains Tax
December 28, 1992
(c) In the case of a transfer which includes other assets which are in addition
to real property or an interest therein and for which there is no reasonable
apportionment of the consideration for such real property or interest, consideration
means that portion of the total consideration which represents the fair market value
of such real property or interest. In the case of a transfer of a controlling interest in
an entity with an interest in real property, there shall be an apportionment of the fair
market value of the interest in real property to the controlling interest for the purpose
of ascertaining the consideration for the transfer of such controlling interest.
(emphasis added) Section 590.47 of the Gains Tax Regulations provides as follows:
590.47 Consideration [Tax Law, §1440(1)]
(a) Question: Is the price paid for the ownership interest in an entity the
consideration for a controlling interest used to calculate gain?
Answer: Generally, no. Section 1440(1) of the Tax Law states that:
" ... there shall be an apportionment of the fair market value
of the interest in real property to the controlling interest to ascertain
the consideration for the controlling interest."
Example:

A corporation's only asset is a $4
million fair market value piece of
property. If 100 percent of the stock is
purchased, the consideration is $4
million ($4,000,000 x 100 percent). If
a 50-percent interest were acquired,
only $2 million consideration is used
to calculate gain.

(b) Questions: How is fair market value determined?
Answer:

Generally, by appraisal. It is the amount a willing
buyer would pay a willing seller for the real property.
It is not net fair market value, which deducts
mortgages on the property from fair market value.

-3­
TSB-A-92(10)-R
Real Property
Transfer Gains Tax
December 28, 1992
Thus, in the example in subdivision (a) of this section, if the property is encumbered
by a $3 million mortgage, and $1 million is paid for 100 percent of the stock, the
amount of consideration for the acquisition is $4 million, not $1 million.
Accordingly, pursuant to Section 1440.1 of the Tax Law and Section 590.47 of the Gains Tax
Regulations the consideration for the transfer of a controlling interest in Petitioner's client to Bank
D is an apportionment of the fair market value of the interest in real property to the controlling
interest being transferred which in the instant case would be $10 million dollars.

DATED: December 28, 1992

/s/
PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.