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. 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. 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.
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.