Drop and Swap Property Purchases: What You Need to Know
While there a several variations, the main idea behind a drop and swap transaction is that real property is changing hands as part of a stock or LLC purchase, rather than by deed. Typically, the seller will convey (or “drop”) the real property into a newly formed entity and then sell this newly formed entity to the buyer (the “swap”). In this legal blog post, our Columbus business lawyer explains what a drop and swap transaction is, why they are used, as well as potential property tax ramifications.
What is a Drop and Swap Transaction?
In a drop and swap transaction, the seller of the real estate does not actually sell real property. Rather, the seller sells all its interest to the legal entity which owns the property. Therefore, although the real property is changing hands, there will be no record of a deed being recorded showing a conveyance from the seller to the buyer.
For instance, suppose you are interested in purchasing a commercial building located at 555 Main Street. After speaking with the owner, you learn that the owner owns the property under the entity 555 Main, LLC. The traditional way to purchase the property would be for 555 Main, LLC to convey the property to the buyer via deed. However, in a drop a swap transaction, the seller would form a new entity, for instance 555 Sub, LLC, drop the property into the sub, (typically via a quitclaim or limited warranty deed), and then sell 100% of 555 Sub, LLC to the buyer. Many title companies are experienced in performing drop and swap transactions and can provide similar safeguards to a traditional transaction, including pulling title reports and insuring title.
Does a Drop and Swap Transaction Automatically Trigger Tax Revaluation of the Property?
No, it does not because no sale for value has been recorded. However, Columbus business lawyers should make their clients aware that it is quite common for an action to be instituted with your county’s board of revision to request that the property be retroactively revalued to the full purchase price paid for the selling entity. These actions are often commenced by the board of education of the city in which the property is located.
However, boards of education are by no means always successful in getting these properties revalued. When actions for revaluation are brought before a board of revision, the central question is whether the real property was sold in an arm’s length transaction and whether the purchase price in that transaction reflected the true value of the property for tax purposes. Orange City Schools Board of Education et al. v. Cuyahoga County Board of Revision, et al., 8th Dist. Cuyahoga No. 107199, 2019-Ohio-634, ¶26.
In resolving this question, boards of revision seem to rely on whether the real property was the only asset owned by the selling entity, or whether an actual business as a going concern was purchased. This differentiation exists because the Ohio Supreme Court has repeatedly held that a sale of an entity’s interest is a sale of personal property and not real property, because the value of the stock or LLC interest represents the company’s value “subject to liabilities, market conditions, and all other factors which contribute to or detract from the value of the property” rather than simply the value of the real property itself. Salem Med. Arts & Dev. Corp. v. Columbiana Cty. Bd. Of Revision, 82 Ohio St.3d 193, 195 697 N.E.2d 978 (1998). Thus, “valuing property based on a company’s stock price fails to account for the complexities of corporate finance.” Id.
Thus, cases which have shown that the selling LLC owns assets in addition to the real property, or that other factors contributed to the overall purchase price, such as an ongoing business, tend to be rejected and not revalued based upon the purchase price of the selling entity. However, the board of revision tends to allow revaluation when it is shown that there was simply an arm’s length transaction to purchase the property and no assets or business as a going concern was involved. In many of these disputes, the board of revision has almost always considered the transaction as reflected in the purchase agreement as well as any appraisals performed by the parties. Undoubtedly, business lawyers throughout Ohio were likely involved in most of these transactions with a potential revision action in mind.
Are There Other Benefits to a Drop and Swap Transaction?
While taxation seems to be the primary reason drop and swaps are utilized, there are other benefits, including additional privacy as well as avoiding conveyance fees. Unlike deeds which have to be recorded and become publicly available, purchase agreements for stock or LLC interests are generally not made public. Thus, one could not ascertain that the property changed hands simply by logging on to their county’s auditor or recorder’s website. Probably more importantly, the purchase price would not be publicized by these same websites (unless of course a revaluation is approved).
Contact our Business Lawyer in Columbus, Ohio for Assistance with Your Business Transactions
Drop and swap transactions are just one of many transactions our Columbus business attorney has assisted clients with. Whether you are looking to purchase commercial property, a business, assets, or you simply need a routine contract drafted, Randol Law, LLC has you covered. Please feel free to contact our law firm to discuss potential representation.