Tax Changes Raise the Cost of Real Estate-Backed Loans

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06/29/2012 1:20 AM

Recording some real estate instruments in Maryland will soon become more expensive. Apparently, the fiscal pressures of the recession have caused Maryland’s government to take action in an attempt to boost revenues. Effective July 1, 2012, the State & Local Revenue Financing Act of 2012 will require taxation of some indemnity deeds of trust and mortgages ("IDOTS"). An IDOT has been used in Maryland when there was a borrower with a guarantor who owned real estate and encumbered it to secure the guaranty. The IDOT model has been used widely because, assuming it met certain conditions, it in most cases avoided costly recordation taxes (under a Maryland Attorney General’s opinion) that would apply to a deed of trust given directly by a borrower. Previously, recordation taxes were not due on the principal amount of the IDOT unless and until the grantor/guarantor became primarily liable for the debt. Under this new law, guaranteed loans in excess of $1,000,000 are susceptible to recordation taxes up to 1 percent of the total loan amount (including the first $1,000,000 secured), and the taxes are paid when the document is recorded. Many IDOTs recorded after the July 1, 2012 effective date will now be taxable.

To take advantage of the IDOT structure and Attorney General’s ruling, some real estate owners have in the past created new shell borrowers who borrowed and then loaned the proceeds of their borrowing to the guarantor, in effect bypassing the otherwise payable tax. In other situations, of course, operating businesses borrowed on the strength of the guaranty of an affiliated landlord supported by an IDOT. While financing supported by real estate security will doubtless still be obtained, some of it, involving guarantor-owned real estate, will become more expensive as a result of this change in the law.

If the new tax wasn’t bad enough, there does not appear to be uniformity among the Maryland counties as to how they will handle certain situations, such as amendments of an existing IDOT and recordation of multiple IDOTs by one party. For example, amending an IDOT to secure an amount in excess of $1,000,000, even if the original IDOT was recorded prior to July 1, 2012, may cause the underlying IDOT to become taxable and incur payment of the tax on the full amount of the secured debt. Also, multiple IDOTs submitted separately by the same party may be added together to determine if tax is due on an overall transaction. However, if the grantor of the IDOTs can prove that the IDOTs relate to separate transactions, even if recorded at or around the same time, the grantor may be able to avoid the tax.

Although there are still many unanswered questions concerning this new Act, the State Department of Assessments and Taxation will be monitoring the effects of these changes, and will have a full report by the end of 2012. If you have real estate interests or assets that you are concerned may be affected by the tax law change or would like to discuss other options available, contact Emerson Dorsey or another member of the Tydings & Rosenberg Real Estate Group to answer your questions.

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