A version of this article was published in The Daily Record on May 20, 2012.
Buried in one of the budget bills that was enacted during the recent Special Session of the Maryland General Assembly is a measure of significant importance to real estate developers, borrowers, and lenders.
The State and Local Revenue and Financing Act of 2012 (SLRFA) amends Section 12-105(f) of the Tax-Property Article of the Maryland Code (“TP”) to impose a recordation tax on an indemnity mortgage or indemnity deed of trust (an IDOT) that is given in connection with a guaranteed loan that is in the amount of $1,000,000 or more. The new law will apply to IDOTs that are recorded on or after July 1.
The new law provides an exception if the recordation tax is paid on another instrument. This is consistent with TP §12-108(e) which provides that no recordation tax is payable on a supplemental instrument of writing.
The Special Session Material, Report on The Budget Reconciliation and Financing Act and State and Local Revenue and Financing Act (dated May 14, 2012) notes that the change in the law affecting IDOTs will generate local revenues of $35,700,000 in fiscal 2013.
IDOT bills, past and present
The bills adopted in the special session were Senate Bill 1302 and House Bill 1802. The IDOT language also was in the two budget bills filed during the regular session, HB 87 and SB 152. Under the regular-session bills, the new IDOT provisions would have applied to all instruments of record on July 1, 2012 and would have presented a substantial issue because of the retroactive effect of the bill.
On the Senate side, the IDOT language was removed from SB 152 and added to SB 523.
Senate Bill 523 passed both houses of the General Assembly, but in different forms. A conference committee was appointed to work out the differences, but the exact language of SB 523 was not agreed to and passed before sine die on April 9.
In the special session, the IDOT provisions of SLRFA were the same as those in Senate Bill 523.
Prior to this year, bills were introduced in the General Assembly to tax IDOTs in every year from 2004 to 2011, other than 2010. The General Assembly rejected each of these bills.
IDOTs have been used as financing devices in Maryland for more than six decades. In general, an IDOT transaction involves a loan made by a lender to a person or an entity (the borrower) and the guaranty of that loan by a different person or entity (the guarantor). In order to secure the guaranty, the guarantor grants to the lender a mortgage or deed of trust (the IDOT) on property that it owns. Importantly for the IDOT structure, the guarantor is not primarily liable on the loan from the lender to the borrower when the IDOT is recorded. In other words, the guaranty is contingent on the occurrence of an event when the IDOT is recorded, such as a default under the loan to the borrower.
IDOTs have been the subject of a number of opinions of the Maryland Attorney General, including three formal published opinions dating from 1944, 1973 and 1989.
Those opinions provide that no recordation tax is due upon the recordation of an IDOT because as to the guarantor, which is the owner of the property encumbered by the IDOT, the “secured debt has not been incurred at the time of recording or filing the instrument of writing.” See TP §12-105(f)(1). When the guarantor becomes primarily liable because the contingency is satisfied (usually when the borrower defaults under the loan), the guarantor then becomes liable for payment of the recordation tax. TP §12-105(f)(2).
Continued use of IDOTs
Under SLRFA, IDOTs may be employed in two situations after July 1. One is for loans of less than $1 million. This provision (part of SLRFA, House Bill 87, Senate Bill 152, and House Bill 523) was included because many advocates of small business argued that the high recordation taxes in Maryland significantly hurt small business owners. Many small businesses borrow money, and their owners guaranty the loans and secure the guaranty with IDOTs on property they own, including personal residences.
Over the years, the case for small business owners was a primary reason why bills that would have ended the use of IDOTs were defeated in Annapolis. By setting a ceiling of $1 million before IDOTs are taxable, transactions that secure relatively small amounts will not be subject to recordation tax.
Also, IDOTs may still be used in nonloan situations where one party (the indemnitor) may become liable to another (the indemnitee), and the indemnitee wants to obtain a security interest in the property of the indemnitor should the indemnitor’s liability become fixed and noncontingent.
An example of when an IDOT could still be recorded without payment of a recordation tax is described in the 1944 opinion of the Attorney General that discussed IDOTs. Under the facts recited, the mortgagors acted as agents and distributors of the mortgagee’s petroleum products and executed a mortgage (the IDOT) to secure any amount that they may have owed after a final accounting between the parties was conducted. The Attorney General opined that the mortgage presented for recording was not subject to a recordation tax under the predecessor of TP§12-105(f) because, at the time the instrument at issue was to be recorded, “the mortgagors were not actually indebted to the mortgagee in any sum whatsoever.” 29 Op.Atty.Gen.Md. at 204.
Alternatives to IDOTs
Without the ability to use IDOTs in real estate financing transactions, lenders and borrowers will now look for other exemptions to the recordation tax statute to enable instruments to be recorded without payment of recordation taxes or to reduce the amount of recordation taxes that would otherwise be payable.
If the borrower is purchasing the subject property within 30 days of when the loan is made, the parties may use the purchase money mortgage exemption under TP §12-108(i).
If the borrower is refinancing a mortgage or deed of trust on which recordation taxes have previously been paid, the parties may use the supplemental instrument exemption set forth in TP §12-105(e)(2) and pay recordation tax on the amount by which the debt is increased from a prior mortgage to a new one. If the lender does not own the debt secured by the prior mortgage, it can first purchase the debt from the previous lender and then amend and restate the loan documents.
Individuals who refinance their principal residences (or trustees or settlors of trusts in comparable situations) may use the refinancing instrument exception of TP §12-105(g) even if the original mortgages are paid off. However, a commercial landowner must be sure that the mortgage or deed of trust it is refinancing is kept alive to use the supplemental instrument exception.
Workgroup on IDOTs
SLRFA directs the State Department of Assessments and Taxation to create a workgroup consisting of representatives of constituent groups of stakeholders to review the impact of the change in the tax on IDOTs on local government revenues and on commercial and residential real estate transactions. The workgroup is to report its findings and recommendations about the tax to the Governor and the General Assembly by December 31. If the members of the workgroup make a compelling case for them, perhaps IDOTs will make a comeback.
Edward J. Levin wishes to thank Cheri Wyron Levin for her advice and editorial suggestions on this article.
1. These bills were: in 2004, House Bill 1490; in 2005, House Bill 665; in 2006, House Bill 454; in 2007, House Bill 409; in 2008, House Bill 260 and Senate Bill 559; in 2009 House Bill 824 (would have been applicable to Montgomery County only); and in 2011, House Bill 420.
2. 74 Op. Att’y Gen. Md. 281 (1989); 58 Op. Att’y Gen. 792 (1973); and 29 Op. Att’y Gen. 203 (1944).
3. Recordation tax rates vary by county or Baltimore City. They range generally from one-half percent to one percent of the amount secured by a mortgage or deed of trust.