FEATURE ARTICLE, OCTOBER 2005

DOCUMENT RECORDING ISSUES IN MARYLAND
An overview of some major issues and problems associated with the purchase/sale of Maryland properties.
Walter Weinschenk

The state of Maryland is a wonderful place in which to live, but, from the perspective of the commercial real estate professional, Maryland can be a cruel and mystifying habitat. The intricacies of the recording process in Maryland and the vagaries of computation of recording taxes are particularly confusing for deal makers and deal closers. This is especially true for out-of-state real estate professionals accustomed to recording systems that are less formal, less expensive and less encouraging of scrutiny on the part of recording clerks.

The vast majority of clerks, attorneys, managers, and the many other state and county workers who run the Maryland recording system are dedicated, adept and courteous.   The difficulties one might encounter in Maryland are not, typically, attributable to mistakes on the part of recording department personnel but are, rather, reflective of the challenging nature of a tiered recording system developed as a means to implement, simultaneously, the policies and requirements of both the state and county.   Unlike simpler recording systems that allow for the “filing” of a deed if accompanied by the requisite filing fee and transfer form, the Maryland process may require that a deed be presented for review at several county and state agency offices. If a deed appears to be complicated or if there seems to be an issue that needs to be addressed, it may be a very long time before that deed is reviewed and allowed to progress through the system. Moreover, there is a great number of rules that govern the recording process in Maryland and some of these rules are quite complicated.   The applicability of particular rules will often depend upon the county in which the property is located, the nature of the transaction and the context in which the deal arises. These factors, collectively, contribute to a recording process that is often time consuming and labor intensive.  

The recording of a deed in Maryland will trigger the imposition of two separate recording taxes. The first of these taxes, known as the state transfer tax, is calculated at the rate of one-half percent of the consideration passed in exchange for the property. The second recording tax is known as state recordation tax. Unlike the state transfer tax, recordation tax rates differ from one county to the next. In addition, some Maryland counties impose a county transfer tax. County transfer tax rates also differ from one county to the next. There are 23 counties in Maryland plus the city of Baltimore and, consequently, the practitioner has a lot of recording tax rates to keep in mind. If, at this juncture, you are beginning to feel queasy, you may be in for a long ride.

Although the imposition of the half percent state transfer tax may seem to be a straight-forward proposition, the imposition of the tax may require one to look carefully at the transaction to determine, precisely, what the consideration is.   The term “consideration” in this context includes, in addition to the cash that the buyer has paid to the seller, “the amount of any mortgage or deed of trust assumed by the grantee, or the principal amount of the secured debt incurred”1 by the buyer on behalf of the seller. “Consideration” may, in fact, include any item or thing of value that is given in exchange for the seller's property.2 The consideration must be recited in the body of a deed or by separate affidavit, and a deed that recites zero or nominal consideration may still be taxed: the clerk is vested with the power and authority to investigate in order to determine the true consideration that underlies an exchange of property.  

As you would expect, the state transfer tax is collected by the state through the auspices of the clerk of the court. The office of the clerk of the court is located in each county of the state and in Baltimore City. The county transfer tax, in contrast to the state transfer tax, is, generally, collected by the counties. In a few cases, however, the clerk of the court collects the county transfer tax. Recordation tax is a stranger animal: some counties have taken on the responsibility of assessing and collecting recordation tax and some have left this function to the state.3 The result is that recording taxes with respect to a singular Maryland real estate transaction will, typically, be imposed and collected by different sovereigns. This point of fact may seem somewhat academic until you consider this simple reality: if you record in Maryland, you have to write checks in Maryland. Mistakes can be made with respect to the preparation of checks for recording and these mistakes can be costly in terms of time and effort. For example, it would be unfortunate, but not a unique experience, for an attorney to close an important commercial transaction, collect the correct amount of transfer and recordation tax, and proceed to write checks to the state and county “in reverse”4 (i. e., so that the “county” transfer/recordation tax check is grossly inadequate and the “state” transfer/filing fee check is grossly excessive).5

Despite the intricacies of the recording process in Maryland, there are a number of circumstances in which the recording of an instrument will be deemed to be “exempt” from the imposition of transfer tax and recordation tax. Exemptions are established by statute and the primary listing of these exemptions appears in Annotated Code of Maryland, Tax-Property Article, Section 12-108. Though the statute pertains only to recordation tax exemptions, the entire list is incorporated by reference into the state transfer tax exemption statute (Annotated Code of Maryland, Tax-Property Article, Section 13-207).

With respect to the imposition of county transfer tax, some exemptions are set forth under state law6 but the availability of county transfer tax exemptions under state law is limited.7   Exemptions from county transfer tax are found, however, within individual county codes. Therefore, it is possible that the recording of an instrument could be exempt from both state transfer tax and recordation tax and yet be fully taxed by the county. It also is possible that the recording of a particular instrument will be deemed exempt from state transfer tax and recordation under state law and, in addition, deemed exempt from county transfer tax pursuant to either state or county law.

Despite the differences between state and county treatment of the exemption issue, Section 12-108 provides numerous categories from which to “choose.” Clearly, the recording tax exemption most often relied upon in both the commercial and residential real estate worlds is the exemption pertaining to the recordation of purchase money mortgages and purchase money deeds of trust. A purchase money mortgage or deed of trust is a security instrument “given by the transferee of real property with respect to the property purchased” to secure all or part of “the purchase money for the property.”8    There are a number of other statutory exemptions that might be particularly interesting to the commercial real estate practitioners such as, for example, exemptions pertaining to (i) conveyances from certain corporations, limited liability companies and partnerships to their original stockholders, members or partners, respectively, upon liquidation,9 (ii) conveyances between parent corporations and subsidiary corporations or between “sibling” corporations,10 and (iii) grants of option agreements for the purchase of real property.11

The challenge is to determine whether or not a particular exemption applies to the complexities of your particular transaction. This sometimes turns out to be an exasperating exercise in light of the fact that parties to a transaction may restructure a deal one or more times before it closes. The restructuring itself may be undertaken in response to the transfer tax reality in Maryland. It is important to bear in mind, at this particular juncture, that the “step transaction doctrine” has been accepted in Maryland. Pursuant to the doctrine, a clerk has the power and authority to scrutinize a transaction and, if appropriate, impose transfer or recordation tax if several “small” steps are taken to avoid tax that would otherwise be imposed if a “direct” recording step had been taken. The taxing authority, pursuant to the step transaction doctrine, may ignore the form of a document in order to understand the true substance of the underlying transaction.12 The doctrine is a means through which a quizzical clerk's momentary glance at a document could evolve, rather quickly, into a detailed study of the structure of a transaction.  

It should be noted that the Maryland tax exemption statutes are strictly construed. For example, the exemption that pertains to transfers between related corporations, referred to above, is strictly limited to transactions involving corporate transferors and transferees. A transfer between a limited liability company and its sole member, a corporation, would be deemed to be outside the purview of the provision. The exemption pertaining to the liquidation, dissolution or termination of certain entities13 would also be read narrowly: the transfer of real property from a partnership upon its dissolution is not exempt if the transferee is someone other than an original partner, a relative within two degrees of an original partner, or someone who became a partner by gift or bequest of an original partner.

Though the exemption statutes are construed strictly, there exist some surprises within the Maryland system that may support a claim for exemption. For example, the term “corporation” that appears in the exemption provision pertaining to transfers between related corporations has been interpreted to include business trusts. The exemption would apply to transfers involving a business trust as either transferor, transferee or in both capacities.

Another surprising exemption source appears in the body Section 12-108 of the Tax-Property Article and might be considered where the transfer of real property by a dissolving entity might not qualify as exempt under Section 12-108(q). This additional “dissolution” provision specifically applies to transfers to a limited liability company where, inter alia, the instrument of writing that transfers title to real property represents the dissolution of the predecessor entity.14 It should also be noted that an exemption provision may not be necessary where a general or limited partnership converts to a limited liability company. If the conversion of that entity is undertaken pursuant to procedures set forth in the Annotated Code of Maryland, Corporations and Associations Article, Section 4A-211, “all property owned by the converting general or limited partnership . . . remains vested in the converted entity.”15

At the risk of engendering a profound sense of discouragement (or annoyance), I will mention briefly the happy subject of lease recordation in Maryland. For purposes of this discussion, “lease” means a lease for a term of more than 7 years not perpetually renewable. As we have discovered, transfer taxes and recordation taxes are usually imposed upon the consideration paid as set forth in a deed. What is the tax basis with respect to a lease that is offered for recordation? The answer depends upon the terms of the lease, which, in turn, will dictate which one of several formulae shall be used to compute that basis. The statute that governs transfer tax computation with respect to leases requires one to ascertain the average annual rent under the lease, minimum average annual rent if the average annual rent cannot be determined, assessment value and other factors. The statute requires, in addition, the ability to do some basic math.   For those who encounter the statute for the first time, the experience can be intimidating and unpleasant.16

Note that county transfer tax will also be assessed on the lease. Usually, the county will tax in a manner that parallels the method set forth in the state statute, but this may not always be the case. As has already been pointed out, a particular county may defer to the dictates of its local code to determine county transfer tax.

The Annotated Code also provides that a “document,” defined to include an attornment agreement, a memorandum of lease, an assignment of lease or “any document that publicizes or gives constructive notice of an unrecorded lease,” may be recorded only if the original lease is submitted and recordation tax on the document and the original lease is paid.17 The recording of a memorandum of lease is, therefore, subject to recording tax. The clerk will require that the underlying lease be produced for review and will examine the memorandum in conjunction with that lease. Note that a “document” publicizing or giving notice of an unrecorded lease may also include a leasehold deed of trust,18 a sublease and even a lease termination agreement.19

Given the complexity and expense of lease recordation, one would not be shocked to discover that many commercial leases pertaining to Maryland real property are kept off-record even though the initial intention may have been to record: there are quite a few 11th-hour “epiphanies” on the part of lawyers and their clients with respect to the subject of lease recordation in Maryland. The Annotated Code of Maryland provides that off-record leases remain valid and effective as between the original parties and as between certain other specified parties.20 Nevertheless, the decision to keep a lease off record may be a risky one. There may be title problems, for example, where a “stray” document cannot be located through the course of a standard title search because of gaps in the chain of leasehold title.   If there are problems, the solutions may be expensive. Note that the title insurance company will, typically, add a “failure to record” exception to a title insurance policy that insures a lessee whose interest is established through a lease that has been kept off record.

Another important aspect of Maryland real estate practice pertains to the sale of the assets of a Maryland corporation. Where there is a sale of all, or substantially all, the assets of a Maryland corporation, the applicable recording procedure will be one that is markedly different from that which would otherwise apply. With respect to such a transfer, recordation takes place “centrally.” Corporate “articles of transfer” are filed at the Maryland State Department of Assessments and Taxation (SDAT) accompanied by a “certificate of conveyance.” All applicable transfer and recordation taxes pertaining to the real estate are paid at the time of filing of the articles of transfer at SDAT.21 Although the “transfer” is said to take place at the time the articles of transfer are accepted by the state, a confirmatory deed is typically recorded among the local land records to reflect the conveyance of the real estate. Receipts reflecting the payment of recordation and transfer tax at SDAT are presented to the local clerks at the time of the recording of the confirmatory deed.22

The complex reality of the recording process in Maryland has resulted in reliance upon certain transactional structures in order to lessen the recording tax impact. The use of a form of security instrument known as an “indemnity deed of trust” (IDOT) is one such mechanism and the IDOT structure has become commonplace in Maryland. IDOTS are a species of deed of trust through which a lender secures a guarantor's performance of its duties set forth in a loan guarantee agreement. Rather than secure the loan by placing a lien against the borrower's real property, the IDOT lender will require that a lien be placed upon guarantor's real property. The IDOT does not secure payment of the debt but, instead, secures the lender against non-performance of the guarantor's obligations. Therefore, the guarantor is the grantor of a deed of trust where the loan funds have been provided to a third-party borrower. Indemnity deeds of trust are not “exempt” from recordation tax but, instead, are “not taxable” at the time of recording. The distinction may be subtle but the theory is that the guarantor is secondarily liable to the lender and, therefore, the liability of the guarantor is only contingent. The imposition of recording tax is triggered at the time the liability of the guarantor is no longer contingent, i. e., upon borrower's default. Once the guarantor has become primarily liable for the debt, recording taxes are due.23

Over the course of the last several years, the Maryland Office of the Attorney General has voiced concern as to the misuse of the IDOT as a tax avoidance mechanism. The specific concern has been that, in some cases, the IDOT is not a true “IDOT” because borrowed funds are channeled, either directly or indirectly, to the guarantor. In these cases, the guarantor of the loan is, in effect, the real “borrower” of the loan proceeds and the named borrower is, in actuality, only an agent through which funds pass. A guarantor may go so far as to deliver a “mirror” note back to the borrower to repay the borrowed funds at which time the borrower may endorse the note back to the lender establishing, in effect, a direct lender/borrower relationship between the funding source and the guarantor.

In light of these concerns, IDOTS presented for recording are subject to a high degree of scrutiny by recording clerks. The clerk will review an IDOT to determine if it is really intended to secure the guarantee and will be sensitive to any indication that the IDOT is being used to secure the original obligation. The clerk will require a copy of the borrower's note or credit agreement for review and may, in addition, require a copy of the settlement statement. Despite the heightened level of review to which it is subject, the IDOT continues to be a popular method through which loans are secured in Maryland.

Another structural “mechanism” that has become popular in Maryland is the acquisition of the controlling interests in entities that own Maryland real property. Where there has been a sale of the shares or interests in an entity that owns real property in Maryland, title to the real property does not change. As a practical matter, however, new owners have replaced prior owners and the equitable ownership of real property has been altered.   Sales of interests in all forms of business entity, including corporations, limited liability companies and limited partnerships, may be the focus of such a transaction. Note that these transfers may not be limited to the shares or partnership interests in a particular ownership entity but may involve changes in the composition of one or more entities that are themselves members or co-venturers comprising the ownership entity.   Moreover, the composition of the ownership entity may remain in tact but, instead, a change may occur with respect to the composition of the parent entity that owns the ownership entity. Such transfers may occur at second, third or higher levels of an inter-related entity structure.

Whether simple or complex, the transfer of control of an entity that owns real property in Maryland does not result in a change with respect to title, a deed of conveyance does not have to be recorded and the transfer tax issue is avoided. The availability of this option in Maryland is in stark contrast to procedures applicable in a number of other jurisdictions where such a transfer is subject to transfer tax.24 It is noteworthy that, as this type of transaction has gained popularity, so too has the demand grown for the inclusion of a “non-imputation” endorsement as part of a purchaser's title insurance policy.25

Numerous other issues related to the recordation process abound. A deed, for example, must include a certificate of preparation indicating that the deed was prepared under the supervision of a Maryland attorney or by a party to the transaction. Real estate taxes must be paid in order to record a deed. In some counties, a “lien certificate” issued by the municipality must accompany a deed for recording.26 In some cases, the clerks will be required to withhold a specified percentage of the proceeds of sale where the seller of the property is not a Maryland resident.27 In some counties, a deed will not be recorded unless a final water reading is undertaken and payment made with respect to the final water bill. In all counties, a deed will not be accepted for recordation unless accompanied by a complete “intake sheet.”28 There are certainly other recording issues that are worthy of discussion but, without going further, it becomes evident that the recording process in Maryland can be a long and winding procedural path.

Some Suggestions

If you are a real estate professional involved in the sale of Maryland real property, it might be worthwhile to consider a few steps that may, ultimately, save time and expense:

• If you are an out-of-state purchaser, seller or attorney representing either party, it may be extremely helpful to hire local counsel. Even a “simple” transaction may be replete with hidden pitfalls that a local real estate attorney would be best able to recognize and grapple with.

• Keep in touch with the title company or law firm that is conducting the closing. The title company will be able to alert you to the nature of any underwriting issues, the progress of the transaction as well as information pertaining to local practice and procedure.

• You may wish to review the Annotated Code of Maryland or any of the county codes. Most of these materials can be found on-line. Rules pertaining to recordation, including local recording tax rates, can also be found through internet research.

• If you have a specific question pertaining to the recordation of an instrument in Maryland, a simple call to the clerk of the court may yield a quick answer. The clerks of the court and staff members of the various county agencies are excellent sources of procedural information.

Understanding the process is the key to success in Maryland. Though some of the more complicated aspects of the recording process have been highlighted in this overview, it is nevertheless the case that the system can be navigated with relative ease by those who are familiar with the rules. If you are able to perceive the elements of a commercial real estate transaction in the context of those rules, your Maryland recording adventure will be straight-forward and successful.

Walter Weinschenk serves as commercial counsel for LandAmerica Commercial Services in Baltimore.

1 Annotated Code of Maryland, Tax-Property Article, Section 12-104

2 A transfer office clerk will often look to the assessed value of a property in order to determine if the consideration stated comports, to some reasonable degree, with the consideration stated in a deed.

3 Recordation tax receipts are shared by the State of Maryland and the particular county in which the tax is collected.

4 The state transfer tax and the clerk's fee for filing are usually paid together in the form of one check made payable to the clerk of the circuit court. The payee named in the county transfer tax check, however, varies from county to county (i. e., “Prince George's County, Maryland”, “Director of Finance”, “Worcester County Treasurer”, etc.) In contrast to this dual payment system, however, is the system administered, for example, in Howard County, Maryland wherein the only payee is the clerk of the court and, consequently, a single check can be used to pay all recording taxes.

5 And, perhaps, purchaser's counsel has requested that documents be recorded immediately and the recording package that you painstakingly assembled, containing the right deed but recording checks that are useless, has already been delivered to a distant courthouse for recording.

6 See, generally, Annotated Code of Maryland, Tax-Property Article, Sections 13-401 through 13-408

7 For example, a lease having a term of seven years or less may qualify as exempt from recordation tax and state transfer tax pursuant to, respectively, Section 12-108(u) and Section 13-207(a)(14) of the Tax-Property Article.   However, there is no county transfer tax “counterpart” in the Tax-Property Article pertaining to leases. Similarly, the recordation of an option to purchase real property is exempt from the imposition of both state transfer tax and recordation tax pursuant to state law.   There is no state law provision, however, that establishes a county transfer tax exemption in the case of an option to purchase.

8 Annotated Code of Maryland, Tax-Property Article, Section 12-108(i)

9 Annotated Code of Maryland, Tax-Property Article, Section 12-108(q)

10 Annotated Code of Maryland, Tax-Property Article, Section 12-108(p)

11 Annotated Code of Maryland, Tax-Property Article, Section 12-108(s)

12 Read v. Supervisor of Assessments of Anne Arundel County, 354 Md 383, 731 A2d 868 (1999)

13 Annotated Code of Maryland, Tax-Property Article, Section 12-108(q)

14 Annotated Code of Maryland, Tax-Property Article, Section 12-108(y)

15 Annotated Code of Maryland, Corporations and Associations Article, Section 4A-213

16 See, generally, Annotated Code of Maryland, Tax-Property Article, Section 12-105(d)

17 Annotated Code of Maryland, Tax-Property Article, Section 12-105(e)

18 A clerk will demand production of a specific lease that is described in an instrument. However, standard financing documents that refer to leases in a general sense, such as standard assignments of rents and leases, are not viewed as “documents” pursuant to Section 12-105(3)(e) and, typically, are not scrutinized for recording tax purposes.

19 It should be noted that a “synthetic” lease is deemed in Maryland, insofar as recordation is concerned, to be nothing other than a true lease and will be reviewed, taxed and recorded in the manner applicable to the recording of any commercial lease.

20 Annotated Code of Maryland, Real Property Article, Section 3-101(d)

21   Note that recordation tax is collected at the state rate. This rate is lower than the rate of recordation tax imposed by the counties.

22 See Annotated Code of Maryland, Tax-Property Article, Section 12-103(d)

23 See Annotated Code of Maryland, Tax-Property Article, Section 12-103 which requires that recordation tax be imposed, in the case of mortgages or deeds of trust, with respect to “the principal amount of the debt secured.”

24 It should be noted that the Maryland legislature has, periodically, considered bills that seek to establish the taxability of these types of transfers. The passage of a statute establishing such a tax may become a reality sooner than some might anticipate or appreciate.

25 A non-imputation endorsement provides that a title insurer will not base a defense to a title claim upon the theory that the knowledge of a departing member has been imputed to the ownership entity.

26 A lien certificate is issued by the county and sets forth the status of county taxes, special benefit tax or levy, or other assessment that may result in a lien. Lien certificates are issued upon application and payment of a fee. They are valid for a specified period of time and must be renewed upon expiration. Any unpaid tax or charge set forth on the lien certificate must be paid at the time of recordation of a deed.

27 The Maryland “withholding requirement” became effective in 2003 and was developed as a means to assist the Comptroller of the Treasury collect income tax on capital gains generated by the sale of Maryland real property by nonresidents.   In this regard, a foreign entity that is qualified to do business in Maryland is considered a “resident”.   If a seller is a resident, this fact must indicated within the text of the deed or by separate affidavit.

28 An intake sheet provides basic information about the property including tax account identification number, grantor, grantee, description of property and other pertinent detail. See Annotated Code of Maryland, Real Property Article, Section 3-104(g)

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