Transfer and Recordation Tax Pitfall: Avoid Closing Day Surprises and Tolerance Cures in Deals Involving Tax-Exempt Sellers
March 31, 2011
Transfer and Recordation Tax Pitfall
Avoid Closing Day Surprises and Tolerance Cures in Deals Involving Tax-Exempt Sellers
In today’s residential real estate market just about every deal seems to have some strange angle to it. With the increase in foreclosures, short sales, and sales of bank-owned and servicer-owned properties, real estate professionals, home buyers and home sellers are being exposed to unusual legal issues in almost every transaction.
Today I want to bring your attention to an issue relating to a transfer and recordation tax policy which in most jurisdictions is not new, but which is recently surprising home buyers, and causing headaches and tolerance cure payments for new and experienced real estate professionals alike.
Jane Broker was thrilled when she found a reasonably priced Victorian in an upscale neighborhood just over the Prince George’s County line. Jane’s clients, Sam and Susie Homebuyer, were thrilled too. The house was just what they were looking for, and because Fannie Mae recently bought the property at foreclosure auction and was eager to re-sell, it was very reasonably priced at $450,000. Sam and Susie already had a pre-approval for a $360,000 mortgage loan from their family friend Larry Loan Officer. Although the house was just at the outer limit of their budget, it really was a perfect opportunity.
Sam and Susie called Jane and Larry to get an idea of how much cash they would need to make the deal work.
Larry prepared a Good Faith Estimate of Sam and Susie’s closing costs disclosing a total of $5,400 in transfer and recordation taxes: one-half of the 1.4% County transfer tax ($3,150), plus one-half of the 0.5% State transfer tax ($1,125), plus one-half of the 0.5% State recordation tax for Prince George’s County ($1,125).
Jane also prepared a worksheet for Sam and Susie so that they could prepare for closing costs, and because the contract called for a customary 50/50 split of transfer and recordation taxes, she also disclosed a total of $5,400 for that expense. Because Jane was suspicious about splitting transfer and recordation taxes with a government-sponsored enterprise like Fannie Mae, she called the County Treasury Division to be sure a 50/50 split of transfer and recordation taxes was acceptable with a Fannie Mae-owned property. Over the phone, the Treasury Division service representative assured Jane that if the contract called for a 50/50 split of transfer and recordation taxes with an exempt entity such as Fannie Mae, although Fannie Mae would not have to pay their half of transfer and recordation taxes, the other party would only have to pay the rest of the taxes due—they would not have to pay Fannie’s taxes, too.
Sam and Susie reviewed the good faith estimate and Jane’s worksheet and, even though it would be a stretch, they told Jane to draw up an offer.
Jane submitted a form contract with a Fannie Mae “bank owned property” addendum on behalf of Sam and Susie, and Fannie Mae accepted the offer. The contract called for a short inspection and appraisal contingency period, and provided that transfer and recordation taxes would be divided equally between Fannie Mae and Sam and Susie. Sam and Susie had sold their house in Silver Spring last year and were in a month-to-month lease, so settlement was scheduled for the end of the following month at a title and escrow company recommended by Fannie Mae’s listing agent.
The inspection and appraisal went very well, and Sam and Susie started preparing to move into their new home. A few days before closing the title and escrow company informed Sam and Susie that they received the loan papers early, and circulated a draft HUD-1 Settlement Statement for review. Sam and Susie were shocked at the total cash they were required to bring to closing. They frantically scanned the form and found the discrepancy: their portion of the transfer and recordation taxes were shown as $7,965—$2,565 more than the amount shown on the estimates they received from Larry and Jane.
Thankfully for Sam and Susie (but not for Larry), in the example above Larry likely has to foot the bill for the $2,565 difference between his Good Faith Estimate and the actual closing costs. Transfer and recordation taxes are, for the most part, a zero-tolerance item under the new regulations, and this is almost certainly an incurable violation obligating the bank to reimburse the borrower for the undisclosed costs. But Sam and Susie still felt that shock of surprise, and their confidence in Larry and Jane is almost certainly shaken.
In most real estate transactions in Maryland, technically, the deed transferring title to real property from one party to another and the deed of trust transferring the property, in trust, to secure the mortgage debt of the buyer are both subject to transfer and recordation taxes. In a traditional residential real estate transaction, however, when a deed is recorded “that is subject to the [transfer and recordation] tax,” a deed of trust which secures the purchase money for the property delivered as part of the same transaction is generally exempt from those taxes under the “purchase money” exemption of Section 12-108(i) of the Tax-Property Article of the Maryland Code.
The deed from Fannie Mae in the example above, however, was not completely “subject to the [transfer and recordation] tax.” In a traditional transaction the buyer and seller split the full transfer and recordation taxes imposed on the deed. Even though the buyer only pays half of the tax, the full amount of tax is paid. In a transaction involving a seller which is exempt from the taxes, the buyer still pays their half, but the seller’s half is not paid. Some jurisdictions have taken that fact, coupled with the plain language of the “purchase money” exemption, and decided that in a transaction involving an exempt party the “purchase money” exemption only applies to the portion of the deed for which transfer and recordation taxes were paid. In our example above, the total transfer and recordation taxes due on the deed were $10,800. Because Fannie Mae did not pay their half of the taxes, only $5,400 was actually paid.
In this situation the clerk will usually only apply the “purchase money” exemption to the deed of trust up to the amount of the deed which was taxed—one half of the $450,000 purchase price, or $225,000. The deed of trust in the scenario secured a $360,000 mortgage. $360,000, less the exempt, un-taxed $225,000 equals $135,000 worth of the deed of trust which does not gain the benefit of the “purchase money” exemption. The State is not presently collecting the State transfer tax under these circumstances, so in Prince George’s County, today, the additional tax due would be $2,565 ($135,000 x 1.4% = $1,890, $135,000 x .5% = $675.)
With County and local governments trying to deal with some of the largest budget shortfalls in history, don’t expect these aggressive positions regarding transfer and recordation taxes to change any time soon—and call your settlement attorneys early, and often, whenever you discover an unusual wrinkle in a deal.
For more information regarding our Residential Real Estate Settlements Group or our general real estate transactions and litigation practice, please contact the author at firstname.lastname@example.org, or 301-230-6574.
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.
© Matthew D. Alegi, 2011