By Gregory Reed and Christopher J. Fritz
Indemnity deeds of trust (IDOTs) have been used for decades in Maryland to defer recordation taxes on commercial financing transactions. For the past several years bills have been introduced in the Maryland General Assembly seeking to tax IDOTs when they are recorded among the land records. To date such efforts have failed. As the General Assembly turns to fiscal matters in the final third of its 2012 session, staring at an enormous budget deficit, an effort to tax IDOTs is once again front and center. In fact, this year for the first time, the IDOT tax measure is contained in the Governor's omnibus budget bill, showing a level of support not previously seen on this issue from the O'Malley administration. We will know within 30 days whether this staple feature of commercial finance transactions survives the budget ax.
What is an IDOT?
In a conventional loan transaction, the borrower issues a promissory note to the lender to evidence the loan, and grants a deed of trust on real property owned by the borrower to secure repayment of the loan. The borrower is primarily and unconditionally liable for the loan, and therefore the Maryland recordation tax must be paid on the debt when the deed of trust is recorded. If the loan is advanced in stages, the borrower may elect to pay the tax either on the full loan amount when the deed of trust is recorded, or on each loan advance when made.
In an IDOT loan transaction, the borrower also issues a promissory note to the lender to evidence the loan. However, the borrower is not the owner of the real property that is to (indirectly) secure the loan. Instead, the property is owned by a third party, typically an affiliate of the borrower. The third party gives the lender a guaranty of the borrower's obligations under the note and other loan documents, and secures the guaranty-not the note itself-by an indemnity deed of trust on the property. The IDOT secures only the guarantor's liability (not the borrower's), which is only secondary and is conditioned on, typically, the borrower's default under the note or another loan document. For that reason, the Attorney General of Maryland has opined that, when the IDOT is recorded, the liability secured by the IDOT has not been "incurred" for recordation tax purposes, and therefore no recordation tax is due at that time.
Note that this structure defers, but does not necessarily eliminate, the duty to pay the recordation tax. If at a later date the borrower defaults on its loan and the guarantor becomes primarily and unconditionally liable under the guaranty, the deferred recordation tax will immediately and automatically become due from the guarantor, a tax obligation that is not eliminated by a subsequent cure of the default. On the other hand, if the loan is repaid without a default, potential liability for the recordation tax is extinguished.
What is the dollar impact?
Recordation tax rates vary by county in Maryland, ranging from one-half of 1 percent to 1.2 percent of the principal amount of the secured debt. In the City of Baltimore the rate is 1 percent, so that a developer who borrows $20 million for a Baltimore project, securing the loan with a conventional deed of trust, will pay a $200,000 recordation tax. Under current law, the developer can defer, and possibly avoid, payment of that $200,000 by using an IDOT instead of a conventional deed of trust.
This will no longer be possible if the pending bill taxing IDOTs is passed. (An exemption in the bill, for IDOTs securing loans of less than $1 million, will benefit few if any commercial transactions.) The Department of Legislative Services, Office of Policy Analysis, has estimated that the tax on IDOTs will raise $39.9 million annually on a statewide basis.
When would the bill become effective?
As currently drafted, the part of the omnibus budget bill concerning IDOTs would, if enacted, take effect on July 1, 2012, so that recording an IDOT on or after that date-even if signed before that date-would require payment of the recordation tax, calculated in the same manner as for conventional deeds of trust.
Would the bill apply to existing IDOTs?
Significantly, the bill does not purport to limit its applicability to IDOTs recorded on or after its effective date. Indeed, its language is broad enough that, read literally, it also applies to any currently existing IDOT, regardless of when recorded. That is because the bill seeks to accomplish its goal by simply declaring that, in effect, all IDOT guaranty obligations are subject to the recordation tax when and to the same extent as the underlying debt is incurred, and as if the guarantor were primarily liable for the debt. Thus, when and to the extent that the recordation tax would have been due and payable on an existing loan if it had been secured by a conventional deed of trust, as of July 1, 2012, the tax will become due and payable on that loan even if secured by an IDOT.
For example, if in 2009, in connection with the $20 million Baltimore project loan described above, an IDOT had been recorded, the entire loan amount had been advanced to the borrower, and no default had occurred, under a literal reading of the proposed bill taxing IDOTs, the $200,000 recordation tax that had been deferred in 2009 would become due from the guarantor on July 1, 2012.
While it is possible that those who drafted this bill did not intend the recordation tax to be applied retroactively to existing IDOTs, there appears to be nothing in the language of the bill itself to prevent an aggressive county official, alert for new revenue sources, from seeking to collect the tax from existing guarantor landowners.
Will other exemptions survive?
The proposed tax on IDOTs will not affect other exemptions available for commercial development, such as purchasing existing loan documents and amending a deed of trust already on record (which in many cases results in a tax only on new money advanced as a part of the transaction). Until the dust settles on the current legislative session, practitioners should be careful to consider the costs of alternative deal structures. For example, if a refinancing is set to occur prior to a vote on the IDOT tax, consider whether it might make sense to purchase an existing deed of trust on which tax has been paid, even in a deal where new money is being advanced. It may be cheaper in the long run to pay a small tax on new dollars today, rather than recording an IDOT and facing a possible tax on the entire loan amount when the deal is once again refinanced in a few years.
How can I learn more?
Feel free to contact any of the real estate practitioners in Ballard Spahr's Baltimore or Bethesda offices for advice on IDOT issues or for other Maryland real estate needs.
Roger D. Winston | 301.664.6201 | firstname.lastname@example.org Marc DeCandia | 301.664.6202 | email@example.comTimothy P. Martin | 301.664.6203 | firstname.lastname@example.orgMark D. Jackson | 301.664.6201 | email@example.comErica A. Leatham | 301.664.6254 | firstname.lastname@example.orgShelah F. Lynn | 301.664.6204 | email@example.com
Morton P. Fisher, Jr. | 410.528.5615 | firstname.lastname@example.orgGregory Reed | 410.528.5620 | email@example.comFred Wolf III | 410.528.5632 | firstname.lastname@example.orgMark Pollak| 410.528.5563 | email@example.comRaymond G. Truitt | 410.528.5629 | firstname.lastname@example.orgChristopher J. Fritz | 410.528.5584 | email@example.comThomas A. Hauser | 410.528.5691 | firstname.lastname@example.orgJon M. Laria | 410.528.5506 | email@example.comLila Shapiro-Cyr | 410.528.5624 | firstname.lastname@example.org
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