UPDATE: New case law on affiliated transfers of real estate

A recent opinion from the California Court of Appeal shows why it is so important to carefully understand California's real property tax laws when structuring transfers of real property between affiliates.

In Fashion Valley Mall, LLC v. County of San Diego, 176 Cal.App.4th 871 (Aug., 2009), the California Court of Appeal affirmed a trial court's ruling that a transfer of fee title to a limited liability company in which the transferor indirectly held a 50% membership interest constituted a 100% "change in ownership" for real property tax reassessment purposes. The case related to the transfer (the "Transfer") of a 50% interest in the Fashion Valley Shopping Mall in San Diego (the "Mall") by Equitable Life Assurance Company of the United States ("Equitable") to Simon Property Group, L.P. ("Simon"). The Transfer was made pursuant to a written Contribution Agreement (the "Contribution Agreement"). Equitable and Simon created Fashion Valley MM, LLC ("FVM"), to function as a holding company, and became equal members in FVM, with each of them holding a 50% interest. Equitable and Simon also simultaneously formed Fashion Valley Mall, LLC ("Mallco"), a wholly owned subsidiary of FVM, to hold title to the Mall and act as the management, leasing and development agent for it. At closing, Equitable transferred fee title to the Mall directly to Mallco. The Contribution Agreement detailed an off-record chain of title in which the grant deed conveying the Mall directly to Mallco would be deemed a contribution by Equitable of the Mall to FVM and the contribution of the Mall by FVM to Mallco.

Following the consummation of the Transfer, the San Diego County Assessor (the "Assessor") determined that the transaction resulted in a 100% "change in ownership" of the Mall and it reassessed the Mall pursuant to Section 75.10 of the California Revenue and Taxation Code. Mallco filled an appeal of the assessor's decision. While that appeal was pending, Equitable, Simon, FVM and Mallco entered into an Agreement to Rescind, Restructure and Reform the Contribution Agreement (the "Reformation Agreement") which purported to restructure the Transaction so that it caused a "change in ownership" of only 50%. Mallco relied on the Reformation Agreement in its appeal. The appeal was ultimately denied. Mallco then filed an action for refund of real property taxes, seeking a ruling setting aside the Assessor's reassessment of the Mall. The trial court ruled in favor of the County of San Diego, upholding the Assessor's 100% "change in ownership" determination. Mallco appealed that judgment as well.

The Court of Appeal upheld the trial court's ruling. First, the Court of Appeal held that the Reformation Agreement was an after-the-fact, sham transaction that was ineffective to change the terms of the Transaction for purposes of its analysis. As the Court of Appeal explained, since the Reformation Agreement had no economic substance other than to avoid tax liability, it was a legal fiction that could not be given effect for purposes of determining Mallco's real property tax liability.

Focusing on the Transaction as originally consummated pursuant to the Contribution Agreement, the Court of Appeal rejected Mallco's argument that even if the Reformation Agreement was not applicable, there was only a 50% "change in ownership" in the Mall. Mallco argued that Equitable retained a 50% beneficial interest in the Mall following the conveyance to Mallco since Equitable was a 50% member of FVM (which in turn was the sole member of Mallco) and had the ability to exercise some degree of control over the Mall. The Court of Appeal rejected this argument, holding that Equitable's status as a member of FVM did not give it any beneficial interest in the Mall. Therefore, according to the Court of Appeal, the conveyance of the Mall to Mallco produced a 100% "change in ownership" and triggered a complete reassessment for real property tax purposes.

Fashion Valley Mall illustrates two important lessons. First, after-the-fact attempts to fix legal missteps cannot be used to rectify those missteps. Second, a member of a limited liability company that owns real property does not have a beneficial interest in that real property for real property tax reassessment purposes, and, therefore, a transfer by a person or entity to a limited liability company in which it holds less than all of the membership interests will be a 100% "change in ownership" triggering a full reassessment.¹

 ¹This posting is intended to summarize recent developments in the law for informational purposes only. It is not intended, and does not constitute, legal advice. We make no warranties of its completeness or accuracy. Because questions regarding the application and interpretation of these and other laws require qualified legal analysis, we ask that you direct any such questions to us following an appropriate, formal retention.