After 17 years of debate, the Maryland General Assembly has passed a new transfer and recordation tax on the transfer of “controlling interests” in a business entity that owns real estate in Maryland. This new tax is one of the “corporate loopholes” sought to be closed by Governor O’Malley in the recent Special Session of the General Assembly. It is based on similar taxes in Delaware, Pennsylvania, New York and the District of Columbia and will become effective in Maryland on July 1, 2008.
Current System. The current transfer and recordation
tax regime in Maryland imposes such taxes upon the privilege of recording an “instrument
of writing” (e.g., a deed) in the land records. The combined transfer
and recordation taxes in Central Maryland (up to 3 percent) are some of the
highest rates in the United States.
Reason for Change. Because of the high incidence of transfer
and recordation taxes in Maryland, commercial real estate owners for years
have sought to avoid such taxes by selling up to 100 percent of the intangible
ownership interests in a business entity that owns the real estate. Because
such transfers do not involve an “instrument of writing” that
is recorded in the land records, no transfer or recordation tax applies. Meanwhile,
when a pass-through entity such as a partnership or LLC is purchased, the underlying
entity can “step up” its income-tax basis in the property to reflect
the purchase price paid. The Maryland State Department of Assessments and Taxation
(SDAT) has complained that it is not able to readily obtain the purchase price
or value of the property involved for real property tax assessment purposes,
since the consideration is not disclosed in any public filing.
History of Proposal. Because of this perceived abuse,
Maryland legislators have proposed extending the transfer and recordation tax
to the transfer of “controlling interests” in a “real property
entity.” This proposal dates back to 1991, but has never been approved
by the Maryland Senate until this year. While New York, Pennsylvania, Delaware
and the District of Columbia have such statutes, this is a not a uniform statute,
so the words and phrases in Maryland’s new law will need to be interpreted.
Summary of New Tax. The new law (contained in Tax Property
Article §12-117(c) and §13-103(b)) provides for a transfer and recordation
tax on the transfer of a controlling interest in a real property
entity, thereby taxing the transfer to the same extent as if the real property, directly
or beneficially owned by the real property entity, was conveyed by an instrument
of writing that is recorded with the clerk of the circuit court for a county
or filed with the SDAT. A “controlling interest” is defined to
mean more than 80 percent of: (a) the total value of all classes of stock of
a corporation, (b) the total interest in capital and profits of an unincorporated
entity or (c) the beneficial interest in a trust. A “real property entity” (RPE)
means a corporation, partnership, association, limited liability company, limited
liability partnership, other unincorporated form of doing business or trust
that directly or beneficially owns real property that: (a) constitutes at least
80% of the value of its assets; and (b) has an aggregate value of at least
$1.0 million. However, an RPE does not include an entity with land holdings
that are subject to an agricultural use assessment (i.e., a farm). “Real
property” means real property located in Maryland; however, it does not
include unrecorded leases or mortgages, deeds of trust or other liens on real
property that secures a debt on real property.
The tax is imposed on the consideration payable for the transfer of the controlling interest. The consideration includes any mortgage or other lien on the real property owned by the RPE and any other debt or encumbrance of the RPE. However, such consideration is reduced by the amount allocable to other assets of the RPE. If the RPE fails to establish the consideration, the tax is imposed on the assessed value of the real estate.
Reporting. The RPE must file a report with the SDAT of
any transfer of a controlling interest in the RPE that is completed within
a period of 12 months or less, within 30 days following the date of the final
transfer. The report shall include the consideration paid, the amount of excluded
assets and any exemption claimed. Any tax due is an obligation of
the RPE (not the transferor or transferee).
Exemptions. Several exemptions will apply as follows:
(a) the same exemptions are to apply as the statutory exemptions for instruments
of writing in TPA Section 12-108 (including between spouses, corporate transfers,
complete dissolutions, LLC conversions, etc.); b) transfers completed over
a period of more than 12 months or not made in accordance with a Plan of Transfer
are also exempt. (A Plan of Transfer does not include a series of sales of
shares of a publicly traded entity); (c) exemptions also apply to transfers
of a controlling interest to another business if the transferee business entity
is held by the same persons and in the same proportions, as well as transfers
by or to subsidiary corporations; and (d) transfers to a non-stock corporation
that is registered with the Department of Aging as a continuing care retirement
community are also exempt. Other exemptions include: (i) the pledge of stock
or other interest in an RPE as security for a loan; and (ii) the admission
of additional equity owners to the RPE incident to the raising of capital if
(a) effective management is not changed and (b) the new members are not expected
to participate in the day-to-day management of the RPE.
Constitutional Limitations. There will be some valid
questions about the ability of Maryland to reach and tax out-of-state transfers
of controlling interests. For example, in Northern Central Railway vs. Fidelity
Trust Company, 152 Md. 94 (1927), the Maryland Court of Appeals recognized
that a state may not impose an inheritance tax on the transfer of stock in
a foreign corporation owned by a non-resident merely because the corporation
was doing business, and had a large proportion of its property located, in
the taxing state. Accordingly, Maryland may have a difficult time taxing transfers
by out of state owners of controlling interests.
SDAT Regulations. The SDAT is to promulgate regulations,
including additional standards and exemptions. It remains to be seen how the
SDAT will extend or interpret the §12108 exemptions (which apply to instruments
of writing) to transfers of controlling interests. Also, it is unclear whether
the SDAT has authority to adopt other exemptions. For example, many transfers
may meet the statutory exemptions in the new statute. But will they still need
to be reported? If so, the SDAT may be inundated with reports claiming exemption
from the new tax.
Conclusion. The new tax will change the way buyers and
sellers transfer real property in the State of Maryland. However, it remains
to be seen whether the new law will have the intended effect sought by the
Governor and the General Assembly.
Robert M. Ercole is a principal in the law firm of Neuberger, Quinn, Gielen, Rubin & Gibber, P.A., in Baltimore, Maryland, concentrating in corporate, tax and real estate law.
