Coming This Summer: New Recordation, Transfer Tax Legislation

By Walter Stone

In the wee hours of Nov. 19, 2007, during a three-week special session of the Maryland General Assembly, the Tax Reform Act of 2007 was voted on and passed legislative muster.
The act included new legislation that imposes recordation and transfer taxes on the transfers of a controlling interest of a real property entity directly or beneficially owning real estate in Maryland. The new legislation will be effective on all transfers occurring on or after July 1.
The act defines "controlling interest" as more than 80% of either (i) the total value of all classes of stock of a corporation; (ii) the total interest in capital and profits of a partnership, association, limited liability company or other unincorporated form of doing business; or (iii) the beneficial interest in a trust.
It further defines "real property entity" as 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 (i) constitutes at least 80% of the value of its assets; or (ii) has an aggregate value of at least $1 million. The taxes are imposed on the consideration payable for the transfer of the controlling interest in the real property entity.

Changes to Come
Currently, the applicable Maryland recordation and state and local transfer tax statutes impose such taxes on instruments of writing (e.g., a deed) recorded in county (or Baltimore City) land records which transfer title or an interest in real property. The combined taxes range from 1.205% in Allegany County to 3% in Baltimore City.
Prior to the act, entities that solely owned real estate would likely opt to have its ownership interests transferred rather than transfer the underlying real estate to reduce the amount of taxes paid on such a transaction. The act attempts to close this perceived loophole in the Maryland recordation and transfer tax statutes by imposing such taxes on the transfer of business interests of real property entities.
One of the most important aspects of the act is that the taxes are imposed on the consideration payable for the transfer of the controlling interest in the real property entity, which appears to include the entire amount of any mortgage, deed of trust, lien or security interest, or any other debt or encumbrance of the real property entity.
In other words, if Blackacre LLC owns property valued at $1.5 million with an outstanding mortgage of $1 million, and the sale price of 80% of the ownership interest in Blackacre LLC is $400,000, then the taxes would be imposed on the sale price, plus the entire mortgage, for a total of $1.4 million.
It is still unclear whether any further guidance will be provided on this particular aspect of the statute since such an interpretation could lead to over-taxation of such transactions.

What Doesn't Apply
There are certain exemptions outlined in the act, a few of which are set forth herein.
For instance, the taxes are not imposed if the transfer is completed during a period of more than 12 months or the transfer is not made in accordance with a plan of transfer. A plan of transfer is defined under the act as an intentional plan or program to transfer the controlling interest in a real property entity, but does not include a series of sales of shares of a publicly traded entity.
Even in its simplest interpretation, it is still not clear whether completing a transfer in 13 months shall be deemed as a plan of transfer. Another exemption allows a transfer of a controlling interest in a real property entity if the parties making the transfer are the same parties receiving the controlling interest, and in the same proportions. A transfer to a subsidiary corporation is also exempt. However, a transfer to a subsidiary limited liability company is not exempt.
It is still unclear how the state of Maryland will enforce the act, since the burden is completely on the real property entity to report a change of a controlling interest. Nevertheless, the taxes must be paid within 30 days after the final transfer. A final transfer is defined under the act as the transfer of any portion of a controlling interest that completes the transfer of a controlling interest in a real property entity.
The penalty for failure to pay the taxes is 10% of any unpaid taxes, plus interest accruing at a rate of 1% per month on any unpaid amount. Under the act, the Maryland State Department of Assessments and Taxation (SDAT) has been tasked with adopting regulations to enforce the provisions of the act, which shall ensure, among other things, that the taxes are imposed on transactions structured to avoid payment of the taxes.

For Inquiring Minds
There are many unanswered questions regarding the act. For instance, the act does not address the issue of indirectly owning a controlling interest in a real property entity. For example, will a holding company that is the sole member of a real estate entity trigger the payment of the taxes if the owner of the holding company sells its membership interests in the holding company?
Another issue is whether a real property entity (e.g., a limited liability company) must report a transfer of a controlling interest upon the death of its sole member. The SDAT regulations may or may not answer these issues.
However, now is the time to plan for the July 1 effective date of the act.

Walter Stone focuses on acquisition, sale, development and management of commercial real estate with Adelberg, Rudow, Dorf & Hendler. He can be contacted at 410-539-5195 and wstone@adelbergrudow.com.