Transfer Taxes

Malba Cove Properties, Inc. v. Tax Appeal Tribunal of the State of New York

Court: Supreme Court of New York, Appellate Division, Third Judicial Department
Docket #: Not Mentioned
Citation: 2014 NY Slip Op 00145 /td>
Plaintiff: Malba Cove Properties, Inc. et al.
Defendant: Tax Appeal Tribunal of The State of New York et al.

Facts: Plaintiff Chang Yi Chen alleged that Defendant Zhen Huang, Esq., failed to properly effectuate a real estate transaction intended to be structured as a "like-kind exchange" under Internal Revenue Code (26 USC) § 1031 in order to defer payment of capital gains taxes on the transaction. Plaintiff alleged that he approached Defendant, who held herself out as an attorney who specialized in real estate transactions for advice regarding the tax consequences of selling property he owned in order to purchase another property. Defendant allegedly informed Plaintiff that he could avoid paying capital gains taxes on the sale and purchase of a new property by way of a Section 1031 transfer. Plaintiff thereafter retained Defendant to represent him in the sale and purchase of properties through a Section 1031 exchange.

On May 28, 2009, Plaintiff entered into an agreement to purchase a property and on June 15, 2009, reached an agreement to sell the property he owned. Plaintiff alleged that these properties qualified as "like-kind property" for purposes of a Section 1031 exchange. The closing for the sale property occurred on September 1, 2009, and Defendant held the proceeds of this sale in escrow until September 2, 2009, when she transferred these proceeds back to Plaintiff. At a closing held on November 1, 2009, Plaintiff used these sale proceeds to purchase the purchase property. Although Plaintiff believed that these actions were sufficient to qualify for Section 1031 tax treatment, the United States and New York State tax authorities thereafter issued tax warrants notifying Plaintiff of deficiencies and penalties because the property transfers did not qualify for Section 1031 treatment. According to Plaintiff, the transfer did not qualify for such treatment because the proceeds from the sale of the sale property were held by Defendant in escrow and then released directly to Plaintiff in contravention of Section 1031's requirement that such proceeds be held by a "qualified intermediary."

Defendant moved for summary judgment dismissing the complaint on the ground that, regardless of whether she committed malpractice in failing to effectuate a Section 1031 Exchange, Plaintiff did not allege any compensable damages. Defendant asserted that, "Plaintiff only seeks to recover the tax liabilities he incurred from the sale of the property he sold.” According to Defendant, such damages are not recoverable because a Section 1031 exchange only defers the payment of capital gains tax until the replacement property is sold, and that as such, Plaintiff may not recover the capital gains tax he was required to pay, since such a recovery would constitute a windfall. In addition, as Plaintiff has not sold the purchase property, a determination of the taxes he will owe with respect to the sale of the property would be unduly speculative.

Holding: The Court granted Defendant’s Motion and dismissed Plaintiff’s Complaint. Defendant correctly asserted that taxes paid are generally not recoverable as damages under New York law. This is because tax liability results from a taxable event, and allowing recovery for the payment of such tax would therefor constitute a windfall for a plaintiff. In addition, damages that are uncertain or unduly speculative may not be recovered in New York.

These principles precluded Plaintiff from recovering as damages the amount he paid to the IRS as capital gains taxes, at least on the facts here, where Plaintiff had not sold the replacement property. In this regard, in a properly completed Section 1031 exchange, the basis from the property sold becomes the basis for the replacement property, and the recognition of any gain or loss is deferred until the replacement property is sold in a sale that does not involve a Section 1031 exchange. The tax consequences of such a deferral depend on many factors, including any change in the capital gains tax rate, IRS rules for determining capital gains, market forces affecting the value of the property, and plaintiff's ability to offset the gain against the losses As Plaintiff has not sold the purchase property, any determination at this time that his capital gains liability would be less at the time of a future sale of the purchase property than he was actually required to pay involves future changeable events, and was inherently speculative.

Prevailing Attorneys : Winget, Spadafora & Schwartzberg, LLP

Precis: Joel Grossbarth


Chang Yi Chen v. Zhen Huang, Esq.

Court: Kings County Supreme Court
Citation: 43 Misc. 3d 1207, 2014 NY Slip Op. 50517(U) (Sup. Ct., Kings Co., 2014)

Facts: Plaintiff is appealing a determination by the Defendant on the payment of real property transfer gains tax on property sold to the City of New York under eminent domain. However, it was unclear if the Plaintiff originally owed such taxes since the City claimed ownership of the property was in question, but also concurrently proceeded condemnation proceedings under eminent domain, naming the Plaintiff as having a possible interest. The Plaintiff would not have owed any taxes if the City, in fact, owned the property. The determination of ownership was found in the Plaintiff's favor after an 11-year proceeding, during which the transfer tax law was repealed. Following the ownership determination, the transfer of the property was completed to the City. The Plaintiff is contending that they should not owe the transfer tax, as the transfer occurred after the law was repealed.

Holding: The Supreme Court ruled in favor of the Plaintiff, stating that the transfer of the property occurred after the transfer tax law was repealed, and thus the Plaintiff does not owe any transfer tax. The Court determined that it was originally unsettled as to whether the transfer of the property had occurred, given the unique circumstances of the City claiming ownership of the property as well as concurrently pursuing eminent domain proceedings. The Court found that the Plaintiff was legally precluded from the property after the determination of property ownership was decided in the Plaintiff's favor, at which point, the transfer tax law had already been repealed. Thus, the transfer tax should not have been imposed.

Submitted: Phillip Sanchez www.spny

Precis: Faisal Sheikh