A version of this article was published in The Daily Record on May 17, 2013.
Recent Maryland legislation will change the law affecting indemnity mortgages and indemnity deeds of trust (“IDOTs”) as well as refinancings in this state generally. Effective July 1, the new law raises the size of loan transactions involving IDOTs which are taxable when they are recorded from $1 million to $3 million, and it changes the way refinancings in Maryland are taxed.
Recordation taxes in Maryland are imposed on instruments of writing recorded in the land records or at the State Department of Assessments and Taxation. Each of the 24 Maryland jurisdictions is entitled to set its own tax rate, which rates range from 0.5 percent to 1.2 percent. 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.
In order to avoid paying recordation taxes when security instruments were recorded, for decades IDOTs were the predominant financing device by Maryland real estate finance practitioners in refinancing transactions.
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, recordation tax is not due at the time an instrument is recorded if, or to the extent that, the debt has not been incurred.
Based on opinions of the Maryland Attorney General’s Office published in 1944, 1973 and 1989, this statute has been interpreted to mean that if the landowner is not primarily liable under its guaranty when the loan closes (that is, if the guaranty provides that the landowner is not liable unless and until the borrower defaults under the note), then no debt is incurred when the IDOT is recorded. Hence, no recordation tax is then due.
One of the key witnesses in the trial in My Cousin Vinnie said, “No self-respecting Southerner uses instant grits.” In this state it might have been said, “No self-respecting Marylander refinances a loan without looking hard at an IDOT.” But the golden age of the IDOT in Maryland is nearing its end.
2012 legislation on IDOTs
As may have been expected, tax collectors were not happy about those cases in which IDOT guarantors and loan borrowers were related parties because many potential tax dollars were not collected. After years of efforts to stop the use of IDOTs, in the First Special Session of 2012, the General Assembly passed Senate Bill 1302 (Chapter 2), which provides that IDOTs executed in loan transactions in the amount of $1 million or more are taxable when they are recorded.
SB 436 and HB 1209
In response to SB 1302, which many believed would yield much more than the annual amount of $36 million which it was supposed to raise, in the 2013 General Assembly session representatives of the real estate community submitted Senate Bill 436 and House Bill 1209. These 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, whether they be residential or commercial or secured by IDOTs, 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. Maryland law currently includes a provision that refinancings of residential loans are taxable on the new loan amount to the extent that it exceeds the amount of the then outstanding principal balance of the original loan.
The sponsors of SB 436 and HB 1209 and the bills’ primary opponent, 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 Gov. O’Malley signed them into law on May 2, effective July 1.
The 2013 measures (now known as Chapters 267 and 268 of the Laws of Maryland of 2013) are titled “Recordation Taxes — Exemptions.” They make the following changes in Maryland law:
1. IDOTs that secure guaranties given in connection with loans that are less than $3 million will not be taxable when they are recorded. Currently, the threshold is $1 million. The new law requires that all loans in a series that are part of the same transaction must be aggregated to determine if the $3 million level is reached. TP §12 105(f)(7)(iii)(2).
2. The new law 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).
It is my opinion that the provisions in the new law that permit IDOTs to be amended by supplemental instruments merely clarify existing law but do not change it. I testified to this effect before the Senate and the House committees that considered the legislation. 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. Senate Bill 1302, however, 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 SB 1302, but it should apply even before the effective date of the 2013 legislation.
Despite my view on this, 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 some counties’ feeling that SB 1302 indicated a dislike IDOTs, but it is not based on any specific legislative provision. When the 2013 legislation becomes effective, it will be absolutely clear that IDOTs may be modified by supplemental instruments of writing.
Because of the position taken in certain counties, a prudent course of action for borrowers would be to wait until July 1 to refinance a transaction that is now secured by an IDOT so that they will certainly get the benefit of the refinance exemption.
3. 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 by it.
These changes mean 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), the recordation tax would be based on $10 ($110 minus $100). Under SB 436 and HB 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. Recordation tax may be calculated on an IDOT that secures property within and outside of 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). Alternatively, 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 secured by real property in Maryland by arranging for the current lender to sell the loan to a new lender, which will restate the loan documents in accordance with the new financing commitment. This is frequently a cumbersome and expensive procedure, but it is often useful because recordation taxes are now 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. It deletes the requirement that the original mortgagor’s principal residence be security for the loan. 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. Moreover, a refinancing transaction that uses a standard deed of trust or mortgage to refinance a previously existing IDOT should qualify for this exemption.