Tennessee Code Annotated Section 67-4-409 (a)(1) states that ‘[o]n the transfer of a freehold estate, the tax shall be based on the consideration for the transfer or the value of the property – whichever is greater.’
‘Value of the property,’ as used in this section, means the amount that the property transferred would command at a fair and voluntary sale, and no other value.
This code section, and more specifically, the definition of the "value of the property," has had different interpretations as to what value should be used when determining the value of the property transferred for transfer tax purposes, mainly in situations where it is believed that the property value is higher than the contract sales price.
This section has become even more important because of the current state of the real estate industry, where there is a significant amount of foreclosures and subsequently real estate owned (REO) properties on the market.
Arguments have been made, especially in REO transactions, that the value of the property that the grantee is swearing to in the affidavit of consideration should be a higher amount than the contract sales price. Many times, the reason given for wanting to use a higher amount is based on an appraisal that was done in connection with a loan given to purchase the property.
The purchaser is thereby alleging that the property is being purchased at a discounted price and that – at that current moment – the property's value is higher than the contract sales price, and in turn, the higher value should be used on the affidavit of consideration.
This argument would seem to be incorrect based on an attorney general opinion that had addressed a very similar issue, as well as some corroborating case law.
The AG's two cents
In a 1991 opinion, Tennessee's attorney general opined in response to an inquiry as to the proper value to be given to properties in a discounted price situation. Although the opinion did not specifically address REO transactions, it did address a similar situation of builders who sell properties in a development at a contract price below market value to attract buyers but request that the market value amount be used on the affidavit of consideration for transfer tax purposes.
The attorney general stated that "[i]n the discounted price situation, if the transaction is a fair and voluntary sale, then the value of the property is the consideration paid.â�¦The price that was actually paid was the amount paid in a fair and voluntary sale. It must be the value, because the seller might not have been able to command the higher price at a fair and voluntary sale."
An REO transaction is very similar to this situation. After a foreclosure, because of either a lack of upkeep on the part of the foreclosed debtor or because of the property's being uninhabited for long periods of time while on the market as an REO property, oftentimes the property will need repair work – sometimes for functional purposes, sometimes due to vandalism and sometimes purely for cosmetic purposes.
These are just some of the factors that are taken into consideration when the REO property is being listed on the market. Although the property may potentially be worth more, the discounted price usually takes into consideration one or more of the above items.
Another important factor that would seem to be reviewed is that REO contracts usually state that it is an "as is" transaction, where the REO seller is not making the same warranties and disclosures as would be required in a standard real estate purchase and sale agreement, and the purchaser is receiving the property with all defects that may exist, except for what may be disclosed in the actual contract.
Furthermore, the conveyance to the purchaser is also usually done via a special warranty deed, which is basically warranting title against claims that have arisen (or arise) only under the seller. These are just some of the considerations that go into negotiating the real estate contract.
In a fair and voluntary sale, the contract sales price is equated with the fair market value. Fair market value has been defined as "the price that a reasonable buyer would give if he were willing to – but did not have to – purchase and that a willing seller would take if he were willing to – but did not have to – sell."
The buyer and seller in a REO transaction take innumerable factors into consideration and are able to negotiate the real estate contract, thereby making it a fair and voluntary sale, and the contract sales price is the amount that was commanded.
As discussed in the attorney general opinion, under normal circumstances, the consideration that is paid should equate with the amount that would be commanded at a fair and voluntary sale, which would be the contract sales price.
Are appraisals sufficient?
The attorney general's opinion also discusses appraisals and why they cannot be the basis of the value of the property for valuation purposes, mainly because the legislature did not specifically permit this in the statute.
The attorney general discussed a reason as to why the legislature did not include the allowance of appraisals in determining the value of the property, which was to avoid the possible problem of conflicting appraisals.
Furthermore, an appraisal does not necessarily mean that the appraised value is one in which a buyer would pay in a fair and voluntary sale.
Therefore, using an appraised value allows for the possibility of being in violation of the statute. Although it was a case dealing with divorce, in Clement v. Clement, the Tennessee Court of Appeals seemed to take a similar opinion with regard to the value of property and appraisals.
In Clement, the appellate court stated that "[a]n appraisal of real property is, of course, an expert's estimate of the fair market value of the property (i.e., the sales price that the property would bring if it were sold in an arms-length transaction). Such an estimate must be utilized by the courts in a divorce if the jointly held property is not to be sold, as a mechanism for the party being divested of his or her interest in the property to be compensated for that interest."
More importantly, the appellate court went on to state that an appraisal is "not necessary when the jointly held property is sold to a third party; the sales price is the fair market value."
One can extract from the above quote that an appraisal can be a wonderful tool in valuing property when there will not be a fair and voluntary sale to a third party. However, in an REO transaction, we have a fair and voluntary sale.
An appraisal could also be used as a starting point in estimating the value of real property in order to begin negotiations to reach an agreement of the contract sales price between buyer and seller, which, again, would be the value that the property actually commanded at a fair and voluntary sale.
It can clearly be seen that the appraised value could very easily be a different amount than the contract sales price, depending on many factors, including – but not limited to – how much the buyer wants the property and is willing to pay, and how much the seller wants to sell the property and the amount for which the seller is willing sell.
When dealing with extrinsic and intrinsic factors – some of which have been mentioned – the contract sales price, which will take these factors into consideration, should be used as the value of the property on the affidavit of consideration and for transfer tax purposes.
Ted Cummins is the supervising attorney for Wilson & Associates PLLC's Memphis closing department. He can be reached at (501) 219-9388.