Maryland’s General Assembly recently concluded a special legislative session with the enactment of a broad tax legislation package that is projected to raise $1.4 billion in new taxes. Of particular importance to the Maryland commercial real estate industry, the legislation expands the real estate recordation tax to include transfers of a controlling interest in business entities with real property in Maryland.
Existing Taxation Regime
Maryland currently imposes transfer and recordation taxes upon the recordation of an “instrument of writing,” such as a deed, in the land records. Because of the high transfer and recordation tax rates in Maryland, some real estate owners have transferred their properties by selling the ownership interests in the entity that owns the real estate. Since such transfers do not involve a deed that is recorded in the land records, no transfer or recordation tax is collected.
New Taxation Regime
Effective July 1, 2008, Maryland’s transfer and recordation tax will be imposed on the transfer of a “controlling interest” in a “real property entity” as if the real property owned by the entity were transferred by a recorded deed under the existing taxation regime. The tax will apply to all transfers of controlling interests that are completed after June 30, 2008.
“Controlling interest” is defined as more than an 80% interest in: (i) the value of stock in a corporation; (ii) the total interest in capital and profits in a pass-through entity (such as a limited liability company or partnership); or (iii) the beneficial interest in a trust.
A “real property entity” is any trust, corporation, pass-through entity or other unincorporated form of doing business that (i) directly or beneficially owns real property that constitutes a least 80% of the value of its assets, and (ii) has an aggregate value of at least $1,000,000. The value of the real property is the full value without reduction for the amount of any mortgage, deed of trust, or other lien against it. Real property includes a leasehold required to be recorded, i.e., one with a term greater than seven years, but does not include (i) leaseholds with terms of seven years or less that are not required to be recorded; or (ii) a security interest in real property such as a mortgage or deed of trust. If an entity owns property entirely subject to agricultural use assessment, such as a farm, then the entity would not be considered a real property entity.
Exemptions from Tax
The following transfers are exempt from the new tax: (i) if the transfer would have been exempt from recordation tax if it were a transfer by deed; (ii) if the transfer is effected in more than one step and either (a) is completed over a period of more than twelve months, or (b) is not made in accordance with an “intentional plan or program to transfer the controlling interest in a real property entity”; (iii) if the transferee is an entity owned by the same persons and in the same proportions as the transferor; (iv) if the transferor, transferee, and real property entity are each subsidiaries wholly owned by a common parent corporation; and (v) if the transferee is a nonstock corporation and registered with the Department of Aging as a continuing care retirement community.
A pledge of stock or other ownership interest as security for a loan is not considered a transfer of a controlling interest under the new regulations. An exclusion also exists for the admission of new owners incident to the raising of additional capital through a public or private offering, but only if: (i) the effective management of the real property entity is not substantially changed; and (ii) under the terms of the offering, none of the new members is expected to participate in the day-to-day management of the real property entity.
Calculation of Consideration Payable
The tax will be calculated based on the consideration payable for the transfer of the controlling interest. The “consideration payable” will be increased by the amount of all debts owed by the real property entity and all encumbrances against its property. The “consideration payable” will be reduced by the amount allocable to the assets of the real property entity other than the Maryland real property.
Tax Liability and Future Regulations
The real property entity is ultimately liable for the payment of any tax due and any interest and penalties for nonpayment. The amount of the tax is calculated as if the real property had been transferred by deed for the calculated amount of “consideration payable.” The real property entity, as opposed to the transferor or transferee, is obligated to file with the SDAT a report of any transfer of a controlling interest completed within a period of twelve months or less within thirty days of the date of the final transfer. The detailed report must include a description of the amount of consideration and assets other than the real property as well as any claimed exemption together with the proper filing fee and any tax, interest or penalty.
A failure to pay the tax within thirty days of the date of the final transfer will result in a penalty of 10% of the unpaid amount and interest accruing on the unpaid amount at the rate of 1% per month. However, the SDAT does have the discretion to waive the interest or penalty upon the real property entity’s demonstration of reasonable cause.
The SDAT is commissioned with adopting regulations for administering this new tax to “assure that: (i) a tax is imposed when a transaction is structured involving a controlling interest in a real property entity to avoid payment of the recordation tax; (ii) exemptions provided by law when real property is transferred by an instrument of writing are applicable; and (iii) there is no double taxation of a single transaction.” The SDAT’s regulations will determine how this new tax is administered in practice and Sutherland Asbill & Brennan LLP will keep you updated on any important developments.