Hard Money: Property Investing: LLC Transfer Tax Loopholes Closing Across Many States
Be careful about buying that LLC! Maryland is the most recent addition to the list of States making real estate investors and commercial property owners a bit poorer this year by instituting transfer taxes on the sale of an entity such as an LLC that owns real estate.
In a State saddled with heavy transfer and recordation costs for real property transfers (up to 3%, which are some of the highest rates in the U.S.), many investors have for many years taken advantage of a loophole in Maryland law allowing limited liability company transfers to occur without the imposition of these heavy taxes, even if the entity owned real estate. Starting in June, 2008, however, Maryland has closed that loophole. Many other mid-Atlantic States have already, or are about to, enact similar legislation, including Delaware, New Jersey, Virginia, Washington, D.C. and Pennsylvania. Here are some specifics on the new Maryland law (codified in The Annotated Code of Maryland, Tax Property Article, Section 12-117 (c) and 13-103 (b)):
A transfer of a “controlling interest” in a “real property entity” within a 12 month period will now require payment of all applicable recordation and transfer taxes, regardless of whether a Deed is executed or recorded at the County Land Records. The transfer/recordation taxes will be based upon the “consideration payable” in such transactions.
Here are a few issues related to the law:
Definition of “controlling interest”: A controlling interest is defined as being more than 80% of a real property entity, which means more than 80% of the value of all stock in the case of a corporation, or more than 80% of the value of all capital and profits for a non-incorporated entity (such as an LLC), or more than 80% of a beneficial interest in a trust.
Definition of a “real property entity”: A real property entity is one in which Maryland real property comprises at least 80% of the value of the entity’s assets and has an aggregate value of at least 1 Million Dollars (without any reduction for mortgages or debts secured against the real estate).
How to compute the transfer tax on “consideration payable”: This can get a little tricky, but let’s examine a common example. A person sells her 90% interest in an RPE that has an aggregate value of 1.1 Million, of which $900,000.00 represents the value of the real estate, and $200,000.00 represents the value of other assets of the RPE, such as equipment. There is a $500,000.00 mortgage on the property. Transfer taxes will be imposed on 90% of $400,000.00 (the equity difference between $900,000.00 and $500,000.00) plus the full $500,000.00 mortgage, so transfers will be imposed on $860,000.00. (In case you’re wondering why you pay transfers on the full mortgage rather than 90% of the mortgage, so are we. Other jurisdictions such as Washington, D.C do allow for this. Perhaps Maryland will fix this in coming years).
The above is just a basic outline of the new statute. There will be many other issues addressed in the coming months and years:
Can Maryland constitutionally tax transfers of controlling interests by out-of-state owner?
Since the RPE has the responsibility of paying the tax, and not the individuals, don’t the non-selling shareholders get unfairly taxed?
After all, it is the individual selling his or her interest. Shouldn’t that particular buyer and seller bear the transfer tax burden?
How does the buyer of an RPE insure that any prior transfers of controlling interests were properly handled? Were the required taxes paid to the State?
Regardless of how these details are worked out, one thing is certain – buyers and sellers of real estate will now be forced to carefully factor this cost into their transaction decisions.
The legal, mortgage and finance experts at Hard Money Bankers, LLC provide a full spectrum of services related to private/hard money real estate transactions including loan placement; underwriting, title and closing, and loan document production and servicing. Our mission is to make the hard money process as smooth and fast as possible for both our borrowers and private lenders; and maintain the highest level of integrity, accountability and professionalism.
Jeffrey Shiller is a Maryland Attorney specializing in real estate. He is a principal of Hard Money Bankers, LLC. His services include nationwide settlements, loan document production, and structuring creative real estate transactions and hard money deals. Mr. Shiller can be reached at 410.878.7090 or firstname.lastname@example.org