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Update on Legislation Affecting Maryland Transfer and Recordation Taxes
By David M. Cohen, John R. Orrick, Jr. and Ryan B. Hotchkiss
I. Legislative Proposal to Tax Transfers of Controlling Interests in Real Estate Entities
Summary:
On January 12, 2005, House Bill 1, The Public School Construction Assistance Act of 2005 (the “Controlling Interest Bill”), was introduced into the Maryland Assembly. As proposed, the Controlling Interest Bill imposes recordation and transfer taxes on the transfer of a controlling interest in an entity that owns interests in real property in Maryland, but only if the Maryland real property (i) constitutes 80% or more of the value of the entity's assets, and (ii) has an aggregate value of $1,000,000 or more.
Under current law, transfer and recordation taxes apply to transfers of real property located in Maryland, but do not apply to transfers of interests in an entity that owns real property in Maryland. Legislators view the current taxing regime as creating a loophole — by selling the entity owning the property, rather than the property itself, taxpayers may effectively transfer real estate without paying transfer and recordation taxes.
The Controlling Interest Bill, which is substantially similar to several proposals introduced in the House in prior years (none of which passed the Senate), is intended to close the perceived loophole. The Controlling Interest Bill has been titled “The Public School Construction Assistance Act of 2005” because it requires the dedication of a portion of the revenues earned from the imposition of the transfer taxes to a special fund to be used only to provide additional funding for public school construction and renovation in certain distressed counties of the State. According to the Fiscal Note prepared by the Department of Legislative Services, however, the projected funds available to be deposited into the special fund from the taxes imposed under this Controlling Interest Bill are not expected to exceed $12,000,000 per year in any of the next four fiscal years. If enacted, the Controlling Interest Bill would be effective for sales of a controlling interest that occur on or after January 1, 2006. The following is a brief summary of the Controlling Interest Bill.
Discussion:
The Controlling Interest Bill imposes transfer and recordation taxes on the transfer of a “controlling interest” in a “real property entity” as if the real property owned by that entity were itself transferred. For purposes of the Controlling Interest Bill, the term “controlling interest” means (i) more than 80% of the total value of all classes of stock of a corporation, (ii) more than 80% of the total interest in capital and profits of a partnership, association, limited liability company, or other unincorporated form of doing business, or (iii) more than 80% of the beneficial interest in a trust. In general, the term “real property entity” means a corporation, partnership, association, limited liability company, limited liability partnership or other unincorporated form of doing business, or trust that directly or beneficially owns “real property”, which (i) constitutes at least 80% of the value of the entity’s assets, and (ii) has an aggregate value of at least $1,000,000. The term “real property” refers to real property located in the State of Maryland, but does not include certain recorded leases or instruments that secure a loan (e.g., a deed of trust, mortgage, etc.). The value of real property held by a real property entity is determined without reduction for any mortgage, deed of trust, or other lien upon or security interest in the real property. The transfer and recordation tax is calculated based upon the consideration paid for the transfer of the controlling interest in the real property entity. Such consideration includes (i) the amount of any mortgage, deed of trust, lien upon, or security interest in the real property directly or beneficially owned by the real property entity, and (ii) the amount of any other debt or encumbrance of the real property entity. However, the consideration upon which tax applies is reduced by the amount of the purchase price allocable to assets that do not constitute Maryland real property.
The Controlling Interest Bill exempts certain transfers from the transfer and recordation tax, including multiple transfers of a controlling interest if the entire transfer is completed over a period of more than 12 months or the entire transfer is not made in accordance with a plan of transfer, and certain transfers among affiliated entities. Further, by its own terms, the Controlling Interest Bill does not apply to (i) pledges of stock or other interests in a real property entity as security for a loan, and (ii) the admission to the entity of additional shareholders, partners, beneficial owners, or other members incident to the raising of capital in a public or private offering of stock or other interest in the entity, but only if (a) the effective management of the entity is not substantially changed, and (b) under the terms of the offering, none of the new members is expected to participate in the day-to-day management of the real property entity.
In addition to imposing a tax, the Controlling Interest Bill also creates certain filing obligations. Accordingly, if within a period of 12 months or less, there is transfer of a controlling interest in a real property entity, the entity being transferred must file a report with the State Department of Assessments and Taxation. The Report must be filed within 30 days from the date of final transfer. The Report must include all information necessary to establish the consideration paid for the controlling interest, the amount of assets other than real estate owned by the real estate entity, and the exemption, if any, being claimed on the transfer. A $20.00 filing fee and any tax, interest, and penalties due in respect of the transfer must be paid at the time the Report is filed.
II. Legislative Proposal Affecting Indemnity Deeds of Trust
On February 7, 2005, House Bill 655, entitled Recordation Tax – Indemnity Mortgages (the “IDOT Bill”) was introduced. As proposed, the IDOT Bill imposes the recordation tax upon certain mortgages, deeds of trust, and other security interests in real property (collectively, the “Security Instrument”) securing a guaranty of repayment of a loan for which the guarantor is not primarily liable. Accordingly, the IDOT Bill deems the liability evidenced by the Security Instrument to be incurred when and to the same extent as debt is incurred on the guaranteed loan, and the recordation tax applies as if the guarantor, itself, were primarily liable for repayment of the loan. However, the recordation tax would not apply to the extent that such tax is paid on another Security Instrument that secures payment of the guaranteed loan (i.e., the tax will not apply twice). If enacted, the IDOT Bill would be effective as of July 1, 2005.
The IDOT Bill also has been described as a “loophole” closer whereby recordation tax can be avoided by establishing a separate entity as the borrower under a secured loan in addition to the owner of the property which grants the indemnity Security Instrument in lieu of having the Security Instrument granted by the same entity which borrows the funds and owns the property. The Fiscal Note prepared by the State Department of Legislative Services does not provide a definitive estimate of the revenue impact of the IDOT Bill, but indicates that local government revenues would increase by “significant amounts” depending on the number of transactions occurring each year and the value of the transactions. A similar bill was introduced in the Maryland General Assembly last year but was not reported out of committee.
At this time, prospects for passage of both the Controlling Interest Bill and the IDOT Bill are somewhat clouded, as each of the Bills will encounter substantial opposition. Governor Ehrlich is on record as stating that he will veto the Controlling Interests Bill if passed by the General Assembly; however, passage of this Bill could be linked to action taken by the General Assembly on the slots legislation and could therefore make the Governor’s position more difficult. We will continue to monitor the progress of each piece of legislation and provide further updates as conditions warrants.
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