Transfer and Recordation Taxes in the Context of Foreclosure and Deeds-in-Lieu

By: John Farnum and Richard Loube1

This article discusses recordation and transfer tax implications lenders should consider in the context of foreclosures and deeds-in-lieu, using the Washington, D.C. metro area as a case study.

Whether due to hybrid working models leaving office buildings largely vacant, or perhaps other lingering effects of the COVID-19 pandemic, there has been a recent rise in distressed real property assets in major metropolitan markets. This has led to an increase in workouts, deeds-in-lieu of foreclosure (“DILs”), and, in some cases, foreclosure. Where borrowers have defaulted on their loans secured by these assets, lenders are often then in a position of marketing the distressed asset to investors that may be looking to acquire distressed real property, and, one way that lenders are trying to make the investment more attractive is by structuring to minimize transfer and recordation taxes, particularly in the District of Columbia metropolitan market (including D.C., Maryland and Virginia, known colloquially as the “DMV”).

It is well known that transfer and recordation taxes are a considerable transactional cost in the DMV market, especially in the District of Columbia where the combined rate of transfer and recordation taxes is 5% for Class 2 commercial real property. These current rates from D.C. Mayor Bowser’s Budget for Fiscal Year 2020 are set to sunset on September 30, 2023, but that should be monitored in the event these rates are extended as a part of D.C.’s next budget. In Maryland, the statewide State transfer tax rates is 0.5%, and there is also the County transfer tax and State recordation tax, which rates are set by each County. For example, in Prince George’s County, the County transfer tax is 1.40% of the amount of consideration, and the State recordation tax is $2.75 for every $500 of consideration. In Virginia, there is less attention to transfer and recordation taxes – often referred to as grantor and grantee taxes in Virginia – since the rates are lower, but there is still an opportunity for structuring to try to minimize these costs. Statewide, the Virginia State grantor tax is $0.50 for every $500 of consideration, the State recordation tax is $0.25 for every $100 of consideration, and the Local recordation tax is 1/3 of the State recordation tax (or approximately $0.083 for every $100 of consideration).

In each jurisdiction, in determining the amount of transfer and recordation taxes due, whether in connection with a DIL or foreclosure, the local recording office must determine the actual consideration payable for the transfer. In foreclosure sales, this is generally more straightforward, as the local recording offices will tax the amount of the winning bid. With that said, in the District of Columbia, if the Recorder of Deeds (ROD) determines that the actual consideration is “nominal,” then ROD can assess transfer and recordation taxes based on the fair market value – i.e., “100% of the most probable price at which a particular piece of real property… would be expected to transfer…” – of the property instead of the actual consideration.2 Nominal consideration is defined as bearing “no reasonable resemblance to the fair market value of the property,” and, if the actual consideration is less than 30% of the fair market value of the property, then the actual consideration is deemed to bear no resemblance.3 In Virginia, local recording offices also have statutory authority to impose tax on an amount other than the stated consideration where a recording clerk determines that the “actual value of the property conveyed” is greater than the stated consideration.4

Even where lenders are the successful bidder at foreclosure, whether by way of credit bid or otherwise, transfer and recordation taxes generally apply. That being the case, lenders will often try to “flip” the bid to a third-party purchaser to take title to the property out of the foreclosure. However, careful consideration should be given to structuring these types of transactions, as it can be treated as two conveyances and, therefore, subject to double taxation.

For DILs, the analysis can be more involved in determining the actual consideration for a transfer. For instance, in Maryland, the taxable consideration may be the greater of (i) the amount of the indebtedness forgiven and (ii) the fair market value of the real property which typically means the assessed value of the real property as last determined by the State Department of Assessments and Taxation, unless an appraisal is obtained. However, if the mortgage or deed of trust is nonrecourse, then the taxable consideration may be the lesser of (i) the amount of indebtedness forgiven and (ii) the fair market value of the real property.

For transfer and recordation taxes in the context of foreclosure and DILs, much of the guidance comes from, not case law or statute, but opinions by attorney generals and tax commissioners, and in Maryland and Virginia, some counties can even follow their own specific practice. As an example, in the context of foreclosure, Montgomery County’s Department of Finance has, at least in the past, taken the position that the transfer taxes should be based on the amount of the winning bid plus the amount of debt forgiven.

While the above discussion focuses on mortgage lenders, these considerations may be relevant to mezzanine lenders as well, as both the District of Columbia and Maryland have a controlling interest transfer tax (“CITT”) that applies to certain transfers of direct and indirect ownership interests in real-property-owning entities. In the District of Columbia, the CITT – referred to as the “economic interest transfer tax” – applies to a transfer (or series of transfers within a 12-month period) of 50% or more of direct or indirect interests in an entity that, in the previous 12 months, either (1) derives 50% of its gross receipts from the ownership of disposition of D.C. real property, or (2) holds D.C. real property that has a value comprising 80% or more of the value of the entity’s assets.5 In Maryland, the CITT applies to the transfer (or series of transfers within a 12-month period) of 80% or more of direct or indirect interests in a “real property entity,” which is generally defined as an entity that owns Maryland real property that (1) constitutes at least 80% of the value of the entity’s assets and (2) has an aggregate value of at least $1,000,000.6 Thus, an assignment or UCC foreclosure of ownership interests in a real-property-owning entity may be subject to tax as well.

As an aside, unlike Maryland and the District of Columbia, Virginia does not have a CITT. However, Virginia does have less defined authority to impose taxes on certain transfers that are made for the purpose of avoiding transfer taxes.7 For instance, transfer taxes do not apply to a deed transfer when the transfer is made from a parent to a subsidiary where the parent is entitled to receive not less than 50% of the profits and losses of the subsidiary. Thus, the parent could own the subsidiary 50/50 with another party as co-owners and the deed transfer would be exempt from transfer taxes. If, however, the parent then subsequently transfers 50% of the ownership in the subsidiary to the co-owner, resulting in the other party becoming a sole owner of the subsidiary, it may be determined that the transfers were structured to avoid tax that would otherwise be due and payable if the property was transferred directly by deed from the parent to the co-owner. In such a case, taxes would be due on the transfer as if it was effected by deed.

When advising mortgage and mezzanine lenders on foreclosure and DILs, attention should be given to transfer and recordation taxes as a part of the analysis (particularly in the DMV market), as there may be opportunity to make the acquisition of a distressed real property asset a more attractive investment, or to otherwise mitigate losses.

Disclaimer: This is for general information and is not intended to be and should not be taken as legal advice for any particular matter. It is not intended to and does not create any attorney-client relationship. The opinions expressed and any legal positions asserted in the article are those of the author and do not necessarily reflect the opinions or positions of Miles & Stockbridge, its other lawyers, or the ABA.

Endnotes

1 John Farnum is a principal at Miles & Stockbridge, P.C., where his practice focuses commercial and real estate litigation, including, bankruptcy and creditors’ rights, administrative appeals, and zoning, real estate, and business disputes. As a part of his practice, he often advises trustees, receivers, and lenders and other creditors in all phases of business restructurings, foreclosures, receiverships and out-of-court workouts, and has substantial experience representing clients on issues arising from bankruptcy proceedings, including adversary proceedings, preference actions, fraudulent transfer actions and lift-stay motions. Richard Loube is an associate at Miles & Stockbridge, P.C., where his practice focuses on both equity and debt transactions, including mortgage and mezzanine finance for commercial, mixed-use and multifamily residential projects. He also advises clients on various aspects of commercial real estate and finance related to real estate development, including acquisitions and dispositions; commercial leasing for retail, office, industrial and solar; construction; and title matters, such as recorded covenants and easements and title defects.

2. D.C. Code Ann. § 47-802(4); D.C. Mun. Regs. tit. 9, § 502.3.

3 D.C. Mun. Regs. tit. 9, § 502.6.

4. Va. Code Ann. § 58.1-801.

5. D.C. Code Ann. § 42-1102.02.

6. Md. Code Ann., Tax-Prop. § 12-117.

7. Va. Code Ann. § 58.1-811.

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