Fannie Mae has recently authorized the release of funds held in escrow to pay the recordation taxes on indemnity deeds of trust (“IDOTs”) because of the determination that such taxes will never be due from the lenders under the circumstances for which the escrows were established.
An IDOT is a deed of trust which secures a guaranty or indemnification obligation, rather than a direct borrowing obligation. In the past, an IDOT would be used in a commercial mortgage refinance transaction which was structured as a loan to an entity other than the property owner. The property owner then would guarantee the loan and secure that guaranty by granting an IDOT on the property. Historically, regardless of the amount of the loan, an IDOT would not be taxable when it was recorded. In 2012, legislation limited IDOTs that could be recorded without incurring recordation taxes to those that secured loans of less than $1 million. That limit was raised to $3 million in 2013.
Recordation tax was not due on the recordation of IDOTs (and still is not due on the recordation of an IDOT securing a loan of less than $3 million) because under § 12-105(f) of the Tax Property Article of the Maryland Code, recordation tax is only due on a deed of trust to the extent that the amount of the debt is incurred.
At the time when an IDOT is recorded the debt secured by the IDOT (that is, the obligation secured by the guaranty) has not come due; therefore, no recordation tax is then due. If and when there is a default under the promissory note, the default causes the liability under the guaranty to be immediately due and payable, and recordation tax becomes due.
All agree that a default under the underlying loan triggers a default under the guaranty such that the guaranty becomes a primary obligation of the guarantor, and recordation tax becomes due. But who is responsible to pay that tax? And if the tax is unpaid, is there a lien for it that would prime the lender’s lien under the IDOT?
In 2009, Howard County began requiring that if an IDOT went into default and there was a foreclosure of it, the purchaser at the foreclosure sale (whether it was the original lender or a third party) would have to pay the recordation tax that had become due on the IDOT in addition to paying the recordation tax (and the transfer tax) on the new deed. This policy would have had the effect of making the original lender liable for payment of the recordation tax when it became due and/or elevating the claim for unpaid recordation taxes to a priority lien status.
As a result of this policy, Fannie Mae and several other institutional lenders began requiring that, in IDOT transactions, the amount of recordation tax that would have been due on a non-IDOT deed of trust be deposited into escrow at the time of the loan closing so that it would be available to be paid if the IDOT loan went into default.
Recently, Gordon Feinblatt represented five clients in successfully challenging this policy in Howard County. Howard County Department of Finance v. Atapco Howard Square I Business Trust, et al., in the Circuit Court for Howard County, Case No.: 13-C-12-092323. [See Edward J. Levin, “Lenders not liable for recordation taxes on IDOTS,” The Daily Record, Baltimore, Maryland (June 25, 2013).] The Circuit Court of Howard County, in affirming the earlier decision of the Tax Court, held that although the borrowers or guarantors under IDOT loans are liable for payment of the recordation tax if and when there is a default, lenders are not liable for payment of such tax and there is no priority lien in favor of the state or a county for the recordation tax.
Following this decision, Gordon Feinblatt requested that Fannie Mae, which was holding recordation tax reserves in several IDOT loans, release these reserves to the respective borrowers. We were initially informed that Fannie Mae was developing a uniform response for all such requests that it had received, and we were subsequently told that the reserves would be released to the borrowers – which they were.
NOTE: A deed of trust securing a refinance loan on commercial property was generally not exempt from recordation tax. This was changed in 2013 when § 12-108(e) and (g) of the Tax Property Article of the Maryland Code were amended in the same legislation that raised the limit on IDOTs that could be recorded without payment of recordation taxes. With this change on refinancing and supplemental instruments and the limitation on the size of IDOTs that may be recorded tax-free, there has been a significant narrowing of the situations in which use of an IDOT is advantageous.