Know Before You Go: Learn the Tax Incentives of Changing/Moving Your Business
Real Estate/Construction Advisor, Summer 2007 Issue

As real estate developers and owners, you really know how to get deals done. You understand the economics of making or breaking a deal — and that you may need to venture outside your own backyard to expand and find more profitable deals. This may even require crossing state lines into unchartered state tax territory. State taxes can be daunting and very costly because state governments are under tremendous pressure to raise additional revenue. This pressure has forced state and local governments to become more sophisticated in their methods of charging state taxes — a fact you and your CFO should be aware of in the event you expand, acquire, or move your business.

In particular, you, as real estate developers and owners (and those in related business), should consider the following taxes when analyzing the economics of a real estate transaction in any state: corporate income and franchise, sales and use, property, transfer, and employment. In addition to the taxes, developers and owners should investigate potential economic development incentives available to promote new activities.

Corporate Income and Franchise Taxes

Most states have laws that impose a tax at the entity level based upon either income generated within the state or net equity of the company. Many states have adopted the Federal Income Tax Laws for determining the starting point for taxable income. However, each state feels the need to add its own personal touch. Some states require an add back of state income taxes paid to that state. Other states require an add back for state taxes paid to all states. Other state tax adjustments might include officers’ compensation, certain tax-exempt interest, and depreciation to name a few.

Real estate developers and owners should also be aware of the gross receipts tax — particularly in Michigan and Illinois where formal proposals are being drafted or testing the waters. The gross receipts tax is imposed and payable regardless of the entity’s profits. California is the most notable, as all entities operating as limited liability companies are subject to a tax passed on gross receipts.

Sales and Use Tax

Sales and use tax is another major revenue generator for states and may account for one-third of a state’s tax revenue. There appears to be little uniformity between states. Unexpected tax consequences include whether transfers to a partnership constitute an “exchange” for sales and use tax; whether certain products used to develop an asset are subject to sales tax; and whether assets transferred from one state to another state are subject to a sales and use tax when used in a development or sales activity.

Some states are studying the utilization of a sales tax on services. This would affect the service providers associated with real estate development. Such a tax could ultimately further increase the cost of construction and potentially drive down demand — an issue well worth looking into, particularly in this market.

Employment Taxes

State employment tax requirements follow the federal employment tax regulations to determine whether a person is an employee or independent contractor. Employers should be aware that employees from one state traveling to another state for temporary assignments may be subject to employment taxes in the other state.

Credits and Incentives

On a good note, states may aggressively compete to attract new development with tax credits and/or incentive packages. Credits and incentives include, but are not limited to, companies expanding operations, consolidations, and new developments in “economic” or “developing” zones.

Planning for the Future

As real estate developers and owners, you should seek advice from tax professionals. Tax professionals can assist with structural and transactional planning, allowing you to have the ability to implement strategies to achieve state and local immunization. Planning upfront can be the difference between success and failure when conducting business in a new state.