A version of this article was published in the ABA/RPTE eReport June 2013.
In Jeopardy style, here is the answer:
Great crab cakes, fantastic soft-shells (in the 2013 Maryland General Assembly session, the Senate voted for soft-shells to be the official State sandwich), Baltimore Orioles (the team; maybe not so much the bird), 2013 Super Bowl Champions (Evermore!), and indemnity deeds of trust.
And now for the question: What are good things that are unique to Maryland?
Background on IDOTs and Recordation Taxes
For decades, indemnity deeds of trust or indemnity mortgages ("IDOTs") were the financing device of choice by Maryland real estate finance practitioners in refinancing transactions. One of the key witnesses in the trial in My Cousin Vinnie said, "No self-respecting Southerner uses instant grits," but in this state it might have been said, "No self-respecting Marylander refinances a loan without looking hard at an IDOT."
Alas, the glory years of IDOTs have come to pass.
IDOTs are security instruments that are given by a person who is not the borrower of the subject loan. Generally, the grantor of the IDOT guarantees the loan and executes the IDOT as security for the guaranty. Under §12-105(f) of the Tax-Property Article of the Maryland Code ("TP"), recordation tax is not due at the time when an instrument is recorded if, or to the extent that, the debt has not been incurred. The substance of this statute has been in place since 1939. The use of this statute to support IDOTs was first endorsed by an opinion of the Maryland Attorney General in 1944. Subsequent opinions of the Maryland Attorney General published in 1973 and 1989 confirmed this position. The 1989 opinion said that the recordation tax becomes due when the debt becomes incurred, which in the case of an IDOT occurs when the borrower defaults under the underlying loan. At that time, the guarantor has the obligation to pay the tax, but the State does not have a lien to collect it.
Recordation taxes are imposed on instruments of writing recorded in the land records in Maryland or at the Maryland State Department of Assessments and Taxation (SDAT) under Title 12 of the Tax-Property Article of the Maryland Code. Each of the 24 Maryland jurisdictions is entitled to set its own tax rate, which rates range from 0.5% to 1.2%. Although recordation taxes are a creature of Maryland law and therefore should be administered consistently throughout the State, a number of jurisdictions have imposed their own rules about them.
Prior Legislative Attempts and 2012 Legislation on IDOTs
Perhaps unsurprisingly, tax collectors became annoyed about the situations when the IDOT guarantor and the borrower were related parties and many potential tax dollars were not collected in IDOT transactions. For many years, bills were submitted to the Maryland General Assembly that would have ended the use of IDOTs, but before 2012 none of those bills made it out of committee. However, in the First Special Session of 2012, the Maryland General Assembly passed Senate Bill 1302 (Chapter 2), which was a general revenue act. Section 3 of Senate Bill 1302 provides that IDOTs that are given in loan transactions in the amount of $1 million or more are taxable when they are recorded.
The Making of Senate Bill 436 and House Bill 1209
On the assumption that Senate Bill 1302 had widely overshot its mark in attempting to raise about $36 million, representatives of the real estate community submitted Senate Bill 436 and House Bill 1209 in the 2013 Session of the Maryland General Assembly. The bills as originally drafted would have set the threshold for making IDOTs taxable at $5 million. Further, they provided that recordation taxes on refinancing instruments would be based on the increase of the principal amount that may be secured thereby in excess of the principal face amount of the original security instrument (rather than the amount of the then outstanding principal balance of the loan). Of considerable importance, the bills provided that all loans, whether they be residential or commercial or secured by IDOTs, would be subject to this rule.
After hearings in both the Senate and House committees, the sponsors of Senate Bill 436 and House Bill 1209 and the Maryland Association of Counties (MACO) compromised on the final versions of the two bills. The bills were then unanimously passed by both houses of the General Assembly, and Governor O’Malley signed them into law on May 2. The versions of the bills as enacted are described below.
Senate Bill 436 and House Bill 1209 as Enacted
Senate Bill 436 and House Bill 1209 (now known as Chapters 267 and 268 of the Laws of Maryland of 2013) are entitled "Recordation Taxes – Exemptions." They amend provisions of Title 12 of the Tax-Property Article of the Maryland Code effective as of July 1, 2013. These bills do the following:
1. IDOTs that secure guaranties given in connection with loans that are below a certain amount are not taxable when they are recorded. Currently, that amount is $1 million. As of July 1, 2013, this amount will rise to $3 million. The 2013 legislation requires that all loans in a series that are part of the same transaction must be aggregated to determine if the $3 million threshold is reached. TP §12-105(f)(7)(iii)(2).
2. The 2013 legislation changes the definition of "supplemental instrument of writing" to specifically provide that IDOTs are instruments that may be amended by a "supplemental instrument" even if recordation tax was not paid on them. TP §12-101(l)(1). I believe that the provisions that permit IDOTs to be amended by supplemental instruments merely clarify existing law but do not change it, and I testified to this effect before the Senate and House of Delegates committees that considered the bills. This is because TP §12-105(f)(7)(i), which was added as part of Senate Bill 1302, defines and taxes "indemnity mortgages" (or IDOTs) that are given in loan transactions of $1 million or more, but Senate Bill 1302 does not limit the effect of exemptions in other sections of the Tax-Property Article, including the exemption for "supplemental instruments of writing" in TP §12-108(e). Therefore, the exception for supplemental instruments of writing under TP §12-108(e) should not be lost as a result of the 2012 law. Instead, the exception should maintain its validity, even before the effective date of the 2013 legislation.
Despite this analysis, a number of county attorneys have taken the position that if an IDOT is amended before July 1, 2013, taxes must be paid on the full amount of the new indebtedness, without any credit for the amount secured by the original IDOT. This is based on the general feeling that Senate Bill 1302 indicated a dislike for IDOTs, but it is not based on any specific legislative provision. When Senate Bill 436 and House Bill 1209 become effective, it will be crystal clear that IDOTs may be modified by supplemental instruments of writing.
Because of the position taken in certain counties, a prudent course of action would be to wait until July 1 to refinance a transaction that is now secured by an IDOT.
3. The 2013 legislation provides that the recordation tax on a supplemental instrument will apply to the difference between the new loan amount and the outstanding principal balance secured by the instrument being modified "immediately prior to the time the supplemental instrument of writing is entered into," i.e., the "new money." TP §12-105(f)(7)(iii)(3) and TP §12-108(e)(2). The latter section currently provides that supplemental instruments of writing are only taxable on the amount of the increase in the debt secured by the supplemental instrument. The debt secured is the amount stated in the security instrument as the maximum principal amount that may be secured thereby.
This change will supersede a memorandum of advice from the Maryland Attorney General’s Office dated April 1, 2005 that provided that the recordation tax on a supplemental instrument applied to the difference between the new loan amount and the maximum principal balance secured by the instrument being modified. Certain county attorneys have not been following the advice from the Attorney General’s office. Presumably, they will follow the provisions of the 2013 legislation.
The effect of the changes described above is that IDOTs and other mortgages and deeds of trust will be treated in the same way for recordation tax purposes upon refinancings. They may be supplemented and increased, and the recordation tax will be based on the amount of the increase over the principal amount of the debt just before the supplemental instrument is signed.
Example: Consider a situation in which the original loan was $100 and it was paid down to $90, and then a supplemental instrument increases the loan to $110. Under the current law (effective until June 30, 2013), the recordation tax would be based on $10 (which is $110 minus $100). Under Senate Bill 436 and House Bill 1209, the recordation tax would be based on $20 ($110 minus $90) for IDOTs or regular mortgages or deeds of trust. (Unfortunately, and in my view inappropriately, a number of counties are now basing the recordation on the full amount of $110 if IDOTs are involved, and some counties are basing the tax on $20 now.)
4. The 2013 legislation provides that recordation tax may be calculated on an IDOT that secures property within and without Maryland by comparing the value of the property within Maryland to the value of all of the property that is security for the loan (as may be done with other mortgages or deeds of trust), or the tax may be calculated on the amount of debt stated to be secured by the IDOT. TP §12-105(f)(7)(iv).
5. Currently, a commercial borrower may avoid or reduce recordation taxes on refinancings by arranging for the current lender to sell the loan to a new lender, which will restate the loan documents’ provisions in accordance with the new financing commitment. This is often a cumbersome and expensive procedure. Recordation taxes are due only to the extent that the new loan is larger than the maximum principal balance of the old loan.
The 2013 legislation provides that a mortgage or deed of trust is not subject to recordation tax to the extent that it secures the refinancing of an amount not greater than the unpaid principal secured by an existing mortgage, deed of trust, or IDOT at the time of refinancing, if the refinancing is by the original mortgagor. TP §12-108(g). This change will enable borrowers (including commercial borrowers) to get the benefit of the refinance exemption even if their original lenders do not sell their loans to new lenders and even if IDOTs are involved. Under current law, this exemption is available only on the principal residence of an individual borrower. Moreover, because the focus of this provision is on the refinancing by an original mortgagor, rather than on the type of security instrument used, a refinancing transaction that uses a regular deed of trust or mortgage to refinance a previously existing IDOT should qualify for the exemption.
6. The 2013 legislation states that only IDOTs recorded after July 1, 2012 are subject to the provision in TP §12-105(f)(7)(ii), which was added by Senate Bill 1302, that secured debt under IDOTs is deemed to be incurred when and to the same extent as debt is incurred on the underlying loan. Older IDOTs are not subject to this rule.
Although the use of new IDOTs in large financings in Maryland will be sharply curtailed as a result of the 2012 and 2013 legislation, landowners that have encumbered their properties with IDOTs will be able to get a recordation tax benefit when they refinance in the future. Moreover, commercial borrowers in Maryland will not have to arrange for note sales and assignments of loan documents in order to get credit toward recordation tax liability when they refinance their loans after July 1, 2013.