The State and Local Revenue and Financing Act of 2012 (SLRFA) (Senate Bill 1302 and House Bill 1802 ) 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 is effective for IDOTs that are recorded on or after July 1, 2012.
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.
SLRFA directs the State Department of Assessments and Taxation to create a workgroup consisting of representatives 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, 2012. If the members of the workgroup make a compelling case, perhaps IDOTs will make a comeback.
QUESTIONS AND ANSWERS AND PRACTICE POINTERS ABOUT IDOTS 1
1. What happens if you have an IDOT securing $1,000,000 or more that was executed before July 1, 2012, but is recorded on or after July 1, 2012? The instrument will be taxable. The operative date is the date of recording.
2. What happens if you have a $950,000 loan in which an IDOT is recorded and the IDOT is amended of record to reflect that the loan is increased by $100,000? Although there is no official guidance on this, there is a distinct probability that the counties will tax an IDOT on the full amount that it secures once the amount secured reaches $1,000,000. In the example above, the tax would be based on $1,050,000.
3. What if an IDOT that secures $1,000,000 or more that was recorded before July 1, 2012 is amended on or after that date? Although there is no official guidance on this, there is a distinct probability that the counties will tax any amendment to an untaxed IDOT on the full amount that the IDOT secures.
4. What can be done to minimize the need to record an amendment to an IDOT after July 1, 2012? Clearly, certain amendments to IDOTs, such as changes in the property descriptions, will need to be recorded, but others may not. Consider the following:
a. Change in maturity date. Deeds of trust and mortgages are frequently amended because of the change of the maturity date of the indebtedness. However, there is no requirement under Maryland law that the maturity date of the indebtedness be stated in a deed of trust or a mortgage. If an IDOT contains a maturity date, the instrument could be amended by an instrument recorded before July 1, 2012 to delete reference to the maturity date. Then, it would not be necessary to record anything in the land records if, on or after July 1, 2012, the maturity date were changed.
b. Change in the amount secured. Section 7-102(a)(1) of the Real Property Article of the Maryland Code ("RP") sets forth the rule that deeds of trust and mortgages must state the amount of the principal sum secured thereby. However, RP §7-102(a)(2) provides that IDOTs are not subject to this rule. Nevertheless, many IDOTs do contain a statement of the maximum principal amount that they secure. If the amount is stated and it is to be increased, an amendment would have to be recorded. However, before July 1, 2012 the parties could amend an IDOT by deleting reference to the amount secured. Then, it would not be necessary to record anything in the land records if the maximum amount secured were changed on or after July 1, 2012.
c. The law imposing a tax on IDOTs amended only TP §12-105(f) . It did not amend RP §7-102(a). This poses the question of how a clerk would know the principal amount of the debt secured by an IDOT that is taxable under TP §12-105(f) but does not state the principal amount of the debt secured. We can expect the clerks will require the parties to submit a statement of the principal amount of the debt secured in some form.
5. What if two loans involving IDOTs each secure $750,000 and are recorded at or about the same time – will they be taxable? Under a strict reading of the new law, each IDOT should be examined separately, and because each is for less than $1,000,000, neither should be taxable. There is the possibility that a county would contend that two loans from the same lender at the same time secured by two IDOTs from the same landowner (and perhaps relating to loans made to the same borrower) should be aggregated, causing the recordation tax to be due. Perhaps a county will claim that the loans should be combined under the step transaction theory. This does not fit the classic construct of a step transaction under federal tax law, pursuant to which courts look at the substance rather than the form of a transaction. However, the step transaction doctrine or a similar theory may be the basis used to aggregate loans. 2
6. How are IDOTs treated in Prince George's County? Prince George's County is the only jurisdiction in Maryland that imposes a transfer tax on deeds of trust and mortgages. Prince George's County does not have an exemption (or a deferral provision) for IDOTs. Therefore, IDOTs have always been subject to the Prince George's County transfer tax, and the new law will not affect that. As indicated above, IDOTs given in loan transactions over $1,000,000 will also be subject to recordation tax after July 1, 2012.
7. May any IDOTs be recorded after July 1, 2012 without payment of a recordation tax? Under SLRFA, IDOTs will be able to be employed in two situations after July 1, 2012. One is for loans in the amount of less than $1,000,000. This provision 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 $1,000,000 before IDOTs are taxable, transactions that secure relatively small amounts will not be subject to recordation tax.
Also IDOTs may still be used in non-loan 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 non contingent. An example of when an IDOT could still be recorded without payment of a recordation tax is described in the first published opinion of the Attorney General that discussed IDOTs, which was written in 1944. 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 statute that was the predecessor of TP §12-105(f).
8. What are alternatives to IDOTs in loan transactions? 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 §12-108(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. This can only happen, however, if the existing lender agrees to sell its debt or if the existing loan documents require it to do so (unlikely).
Borrowers in new loan transactions may wish to include language in the loan documents that requires the lender to sell the loan to a subsequent lender upon the borrower's request.
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.
1 For purposes of the discussion in this Bulletin, all references to IDOTs are to IDOTs that secure guaranties given in connection with loans and are not supplemental instruments.
2 It is not clear to what extent step transactions exist under Maryland law. The regulations of the Maryland State Department of Assessments and Taxation with respect to transfers of controlling interest (COMAR 18.13.02.00 et seq. ) talk about step transactions, and they rely on Read v. Supervisor of Assessments , 354 Md. 383, 731 A.2d 868 (1999). Step transactions did not exist in Maryland before the Read case, and the Read case did not involve step transactions or recordation taxes. But see Goldstein v. 91st Street Joint Venture, 153 Md.App. 171, 835 A.2d 239.
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.
FOR QUESTIONS ABOUT THE USE OF IDOTS, PLEASE CONTACT ANY OF THE FOLLOWING:
Timothy D.A. Chriss, David H. Fishman, Edward J. Levin, Searle E. Mitnick, Peter B. Rosenwald, II, Seth M. Rotenberg, Neil J. Schechter, Lisa S. Spitulnik, Danielle S. Zoller