Drop and swap tax-saving strategy aided by recent Ohio law

At times, a sale of commercial real estate results in a gain that may be double or even triple the original tax-assessed valuation of a property. Such gains will typically cause RE taxes to likewise double or triple as the county auditor will be notified of the increased sale price when the deed conveyance tax is collected and the deed is recorded. If the transaction can be closed as a drop and swap, that is, without payment of a conveyance tax, and thereby, no notice of the higher sale price to the county auditor, then the investor can avoid a significant increase in the property’s tax valuation and a commensurate RE tax increase that the investor must pay annually. 

Ohio real property taxes

Real property taxes are a major expense for Ohio CRE investors since Ohio is among the top ten states in the United States with the highest RE tax rates, at an average rate of 1.52%. At first glance, this average may seem deceptively low; however, many urban-area tax rates hover between 2% to 4%. Neighbouring states like Kentucky and Indiana have average real property tax rates of just 0.78% and 0.81%, respectively, or nearly half of Ohio’s real property tax rate.    

To compound this major cost, RE taxes are paid annually, and are not just a one-time expense like a buyer’s title insurance premium. Further, real estate taxes almost always increase over time, and rarely, if ever, decrease. 

HB 126: Restrictions on valuation complaints by boards of education

For the above reasons, CRE investors are focused on managing RE taxes and a new Ohio law has a direct impact on slowing tax growth. 

Ohio’s K-12 public education system is the primary beneficiary of the state’s RE tax, with local boards of education (BOEs) typically receiving between 50% to 80%+ of real property tax revenues. House Bill 126, which went into effect 01 July 2022, was aimed at restricting the ability of BOEs to initiate a valuation complaint aimed at increasing tax revenues for BOEs at the expense of CRE investors. 

Prior to passage of HB 126, there had been an epidemic of valuation cases filed by BOEs across the Ohio to increase investors’ taxes any time a deed conveyance tax indicated a transfer had taken place at a sale price greater than the current tax valuation of the underlying property. This practice by BOEs was rampant and out of control. 

In response to this problem, Ohio legislators enacted several significant restrictions on the ability of BOEs to initiate a valuation complaint to raise an investor’s real estate taxes. This new law has significantly reduced challenges to raise a CRE investor’s RE taxes, and is a significant benefit to commercial real estate investors. 

Enter the drop and swap strategy

A drop and swap strategy combined with the benefits of this new law means that investors can feel confident in implementing their tax-saving measures and that their plans will not be up-ended by overly-aggressive BOEs so long as the parameters of each transaction and the law are understood by investor and counsel alike.

CRE investors considering use of a drop and swap or entity purchase structure are strongly recommended to first consult with one of our experienced real estate attorneys who can advise on best practices to structure the drop and swap transaction. There are certain attributes of a traditional purchase and sale transaction that should be avoided. 

Andrew Emmert is a partner in the Real Estate, Banking & Commercial, Business & Transactional, Construction, Estate Planning & Probate and Tax Planning & Compliance practice groups at DBL Law. Drew provides general counsel services to individuals and privately-held businesses in a wide range of industries, and to real estate owners, investors, tenants and developers.