Arizona Real Estate Advisory

Most Arizona cities and towns raise the bulk of their revenue by imposing a transaction privilege tax upon those who conduct business within the municipal boundaries. A number of real estate developers, however, have been surprised to learn that the tax applies to the sale of developed real estate.

When real property is sold, after having been improved with a building or structure or simply the addition of on and offsite improvements such as paving, curbs, gutters, sidewalks and the extension of utilities to the property line, the sale is subject to what is commonly referred to as the “Speculative Builder Tax.” If the improved real property is residential, it is subject to tax whenever sold. If the property is commercial, it is subject to the tax only if sold within 24 months of the date the improvements are substantially completed. Most cities and towns permit deductions for the land component as well as the taxes paid by the general contractor to the municipality during construction of the improvements. If the tax is not paid by the developer seller, the municipality may hold the purchaser of the property liable for the tax under a successor liability theory.

Imposition of the tax is not dependent upon an “arms length” sale of the property. With the worsening economic conditions, we have observed municipalities assessing the tax in connection with foreclosures and trustee’s sales. An owner who did not initially intend to develop his property for sale may become liable for the tax if he defaults on his financing and the property is sold to satisfy the debt. If the owner walks away entirely, the purchaser at the sheriff’s or trustee’s sale, including a lender who places a credit bid, becomes liable for the tax under a successor liability provision in the municipal tax code. The tax is in addition to the income tax consequences resulting from the recapture of depreciation, appreciation, capital gain and relief of indebtedness.

Subsequent purchasers of foreclosed property should also be concerned. If the tax is not paid, the municipality can collect it from any successor. There have been recent claims made against title insurers who insured a subsequent purchaser. It is still to early to speculate, however, on whether title insurance will cover the tax. The bottom line is that both owners and buyers need to be aware of the implications the Speculative Builder Tax may have for improved real property.