In recent months, we have handled a number of residential settlements in Maryland involving out-of-state sellers. Although most real estate agents are familiar with the tax withholding requirements for nonresidents of Maryland, many sellers are completely unaware that they may be subject to withholding. Early communication with sellers regarding their residency is recommended to avoid any unpleasant surprises in the settlement process.
The intent of the law, which is codified in Section 10-912 of the Tax-General Article of the Annotated Code of Maryland, is to set aside funds for possible capital gains realized on the sale of real estate by a nonresident of Maryland. The settlement agent is required to withhold 7.5% of the “net” sales proceeds from a nonresident individual (or 8.25% from a nonresident entity or company) and to remit that amount to the Clerk of the Court with the deed; the deed will not be accepted for recording without payment of the tax withholding. The concept of “net” sales proceeds means that the withholding percentage amount will be calculated on the sales price, minus any mortgage or lien payoffs and other costs of sale such as real estate commissions or transfer taxes (but not including pro-rations or similar adjustments).
It is important to understand that the sums paid to the state are only for potential taxes that may be due; in essence, the tax withheld serves as collateral to ensure that the nonresident seller files a tax return with the state at the end of the tax year. The seller’s Maryland income tax return for the year of the sale will report any gain or loss on the transaction. Based on the final return, if no tax was due on the sale, any excess collected from the seller would be refunded by the state. In fact, a seller may file for a refund of any amount withheld 60 days after the payment, except for during the last quarter of any year.
To avoid withholding requirements, a seller must certify under penalties of perjury that they are a Maryland resident, or if they are not a Maryland resident, that the property being sold was their principal residence. To qualify as a “principal residence,” the property must be: (1) registered as the seller’s principal residence with the Department of Assessments and Taxation (“SDAT”) AND (2) meet the Federal definition of “principal residence” as set forth in the Internal Revenue Code (the “IRC”). Specifically, the seller must have occupied the property as his or her principal residence for an aggregate of two of the past five years. To recap, the property’s registration with SDAT as a principal residence is a threshold question for automatic avoidance of the withholding requirements; if the property is no longer listed as a principal residence with SDAT, then it does not matter if the seller has occupied the property as a principal residence for two of the past five years for the purposes of determining whether the seller can automatically avoid withholding requirements. Therefore, if a seller has moved to another state and changed the property’s status with SDAT from” principal residence” to “rental or investment status” (which SDAT may change automatically if the seller requested a new out-of-state mailing address for tax bills), then withholding would be required, unless the seller applies for a Certificate of Exemption as described below.
In the event that there is no capital gain on the sale, and provided that the seller can document this fact by showing costs of purchase and sale (as well as any reduction in gain from any capital improvements made to the property), the seller can apply for a Certificate of Exemption from Withholding. To obtain a Certificate of Exemption from Withholding, the seller must submit a completed Application for Certificate of Full or Partial Exemption (Maryland Form MW506AE) to the Maryland Comptroller at least 21 days prior to closing, documenting the absence of gain on the sale of the property. Upon review and approval of the application, the state will issue the Certificate of Exemption directly to the settlement agent, and the settlement agent will submit the Certificate of Exemption with the deed for recording in lieu of the tax withholding payment.
Recently, we were made aware of a seller’s Maryland nonresident status only days prior to closing. This necessitated a tax withholding which may have been avoided by a timely filed request for an exemption. Although we have access to all necessary forms and can assist sellers in this process if we have sufficient advance notice, the burden of applying for a Certificate of Exemption ultimately lies with the nonresident seller. We recommend that sellers apply for any exemption immediately upon receipt of a ratified contract of sale to avoid running afoul of the state’s 21-day deadline for filing.
Finally, please note that nonresident withholding is often an issue for sellers in the military, because: (1) they may never have been Maryland residents for tax purposes, even if they were otherwise occupying the property as their principal residence and (2) they may not have owned the property for two full years and as a result are unable to satisfy the IRC definition of “principal residence.”
For more information regarding our Residential Real Estate Settlements Group or our general real estate transactions and litigation practice, please contact the Group Chair at 301-230-6574 or firstname.lastname@example.org.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
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