As you may be aware, the Maryland General Assembly has concluded the special session called by the Governor to address the State’s budget. Among the many changes included in the Tax Reform Act of 2007 is the imposition of recordation and transfer taxes on each transfer of a “controlling interest” in a “real property entity.”

Although Maryland’s recordation and transfer taxes were imposed originally in exchange for the numerous legal benefits derived from recording deeds and other instruments in the public records, such taxes soon will apply to a type of transfer that does not avail itself of those benefits. Depending on the county in which the real property is located, the aggregate tax can range from approximately 1.2% to 3% of the “consideration payable” for such transfers.

The following summarizes the key parts of the new tax:

* Effective Date: The new tax will go into effect on July 1, 2008 and apply to all transfers of controlling interests completed after June 30, 2008.

* Definition of Real Property Entity: A “real property entity” is any type of entity or trust that directly or beneficially owns real property in Maryland if that real property (1) constitutes at least 80% of the value of its assets, and (2) has an aggregate value of at least $1,000,000. The value of the real property is its full value without any reduction for the amount of any mortgage, deed of trust, or other lien against it. Ownership of real property includes a leasehold with a term greater than seven years, but does not include (a) a lease of seven years or less, or (b) a security interest in real property, such as mortgages and deeds of trust.

* Definition of Controlling Interest: “Controlling interest” is defined as more than 80% of the total value of all classes of stock of a corporation, of the beneficial interest in a trust, or of the total interest in capital and profits of any other entity.

* Exclusions: An entity is not a “real property entity” if its real property is entirely subject to agricultural use assessment, other than portions for the homestead and commercial activity related to agricultural production. Also, a pledge of ownership interests as security for a loan is not a transfer of a controlling interest (but an execution or foreclosure on such interests would be). There also is an exclusion for the admission of new owners incident to the raising of additional capital if the effective management of the real property entity remains substantially unchanged and none of the new members is expected to participate in the day-to-day management of the real property entity.

* Reporting Requirements: Unless one of the exclusions discussed above applies, the real property entity itself (and not the transferor or transferee of the controlling interest) has the burden of reporting each transfer of a controlling interest that is completed within a period of twelve months or less. The report must be filed with the Department of Assessments and Taxation (“SDAT”) within thirty days after the completion of the transfer. Regardless whether the transfer qualifies for any exemption from the tax, the report must include the “consideration payable” for the transfer of the controlling interest (as discussed below) and the value of the real property entity’s other assets. In addition, regardless whether any taxes are due with the report, the real property entity must pay a $20 filing fee to SDAT.

* Exemptions from Tax: There are five exemptions from the tax: (1) if the transfer would have been exempt from recordation tax if it were a transfer by deed from the transferor to the transferee of the controlling interest; (2) if the transfer is effected in more than one step and either (i) is completed over a period of more than twelve months, or (ii) is not made in accordance with an intentional plan to transfer a controlling interest; (3) if the transferee is an entity owned by the same persons and in the same proportions as owned the real property entity prior to the transfer; (4) if the transferor, transferee, and real property entity are each wholly owned by a common parent corporation or are such common parent corporation; and (5) if the transferee of the controlling interest is a Maryland nonstock corporation and registered with the Department of Aging as a continuing care retirement community.

* Calculation and Payment of Tax: The tax is calculated based on the “consideration payable” for the transfer of the controlling interest. In addition to the actual purchase price for the interests in the real property entity, the “consideration payable” is to be increased by the amount of all debts owed by the real property entity and all liens against its property. However, the “consideration payable” is to be reduced by the amount allocable to the assets of the real property entity other than its Maryland real property (but no method of allocation is provided). The real property entity bears the burden of establishing these amounts to the satisfaction of SDAT.

* Liability for Tax: The real property entity is the one liable for the payment of any tax due. The amount of tax due is to be calculated as if the Maryland real property of the real property entity had been transferred by a recorded deed for the calculated “consideration payable.” All such “consideration payable” would be subject to the 0.5% state transfer tax. In addition, the “consideration payable” would be allocated to each parcel of Maryland real property owned by the entity and subject to the Maryland recordation tax and, if applicable, county transfer tax at the rate set by the county in which each parcel is located. Combined, these three taxes range from approximately 1.2% to 3%, depending on the county. In addition to the foregoing, SDAT is directed to adopt regulations for administering this new tax and to “assure that: (i) a tax is imposed when a transaction is structured involving a controlling interest in a real property entity to avoid payment of the recordation tax; (ii) exemptions provided by law when real property is transferred by an instrument of writing are applicable; and (iii) there is no double taxation of a single transaction.”

Presumably such regulations also will include a standard form for reporting transfers of controlling interests and a standard method for allocating the purchase price between the Maryland realty and other property.

Although many questions remain unanswered, there are planning opportunities in contemplation of the new tax. If you need assistance with your transactions, please contact Myles Lichtenberg, Esq, at your earliest.

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