In October 2016, the Commonwealth Court of Pennsylvania ruled on Saturday Family LP v. Commonwealth of Pennsylvania. The case focused on whether the commercial lease was subject to Pennsylvania realty transfer tax. In Pennsylvania, any lease that has a term of 30 years or more is subject to Pennsylvania’s realty transfer tax. In determining the term of a lease, certain extensions or renewals are taken into account.
In this case, the tenant entered into a lease with an initial term of 29 years 11 months. The lease contained options that permitted the tenant to renew the term of the lease for six periods of 5 years each, with rent for the renewal terms calculated as fair market value to be determined by the parties at the time of the extension. The Pennsylvania Department of Revenue assessed realty transfer tax because it asserted the lease exceeded 30 years, taking into account the renewal/extension options.
Whether or not the lease was subject to the realty transfer tax depended on the interpretation of several provisions of the Realty Transfer Tax statute and the Department of Revenue’s regulations. The relevant language provides that “[i]n determining the term of a lease, it shall be presumed that a right or option to renew or extend a lease will be exercised if the rental charge to the lessee is fixed or if a method for calculating the rental charge is established.” (§Section 1101-C of the Tax Reform Code of 1971). The regulations provide that “it shall be presumed that a right or option to renew or extend a lease will be exercised if the lessor and lessee cannot renegotiate the rental charges for the renewal or extension period . . . Renewals or extensions at the option of the lessee at fair rental value at the time of the renewal or extension are not included in determining the term of a lease.” 61 Pa. Code § 91.193(b)(24)(v).
The lease provided that rent for the renewal periods would be the fair market value to be determined by the parties at the time of the extension. The tenant argued it qualified under the exception to the rule stating that renewal terms “at the option of the lessee at fair rental value at the time of the renewal” are not included in the term of the lease. However, the lease provided a complex valuation methodology involving multiple appraisals and tiebreakers for determining the fair market value rent in the event the tenant exercised its options. The Department of Revenue argued that the rental charges could not be renegotiated because a formula for determining the fair market value was already provided for in the lease and, therefore, the rent was not truly “negotiable”, making the lease subject to the realty transfer tax.
The Commonwealth Court held that the renewal periods should not be included in the lease term and that the lease was therefore not subject to realty transfer tax. The Court determined that so long as the rent for any renewal term is determined as the fair rental value at the time of the renewal, the establishment of the methodology for determining such value did not render the lease subject to the realty transfer tax.
The Court’s decision provides some clarity to seemingly inconsistent provisions. It provides parties entering into a long-term lease the ability to draft terms that prevent a lease from being subject to the realty transfer tax, while also providing the tenant with the benefit of renewal terms that could extend the lease beyond 30 years. It also provides parties the ability to create a method for determining fair market rent 30 years in the future that is fair to both sides. However, the Commonwealth has filed exceptions to the Commonwealth Court’s decision, which are pending.