Transfer, Recordation, and Documentary Taxes

A deferred exchange involves at least two conveyances and sometimes four, and whether each one is taxed depends on State doctrine that does not always describe the intermediary the way federal law does.

This chapter covers Maryland in detail, because Maryland is where this work is practiced, and uses Pennsylvania for contrast, because its revenue department has reached the opposite conclusion on the central question.

60.1 Whether an exchange is a taxable conveyance

The Maryland taxes. Three taxes apply to a Maryland conveyance.

The State transfer tax is 0.5 percent of the consideration payable for each instrument of writing.¹ For this purpose an instrument of writing is a written instrument that conveys title to, or a leasehold interest in, real property, and it does not include a mortgage, deed of trust, or other instrument creating an encumbrance.²

The recordation tax is set by each county, at a dollar amount for each $500 or fraction of $500 of the consideration payable or of the principal amount of debt secured. A figure that is not evenly divisible by $500 is rounded up to the next $500.³ Unlike the State transfer tax, the recordation tax also reaches instruments that secure debt.

Most counties add a county transfer tax.

An exchange is a conveyance. Nonrecognition for income tax purposes is not an exemption from any of these taxes. As the Maryland practice guide summarizes the Attorney General's position, a basic swap is subject to recording taxes, and each deed is taxable on the fair market value of the property it conveys. Where Abel conveys Whiteacre worth $60,000 and Baker conveys Blackacre worth $60,000, both deeds are taxable on $60,000. Where Abel conveys Whiteacre worth $100,000 plus $25,000 in cash for Blackacre worth $125,000, the deed to Whiteacre is taxable on $100,000 and the deed to Blackacre on $125,000.⁴

Pennsylvania reaches the same starting point. Documents that effect or evidence a transfer of title to Pennsylvania real estate are subject to realty transfer tax, so a deed conveyed in an exchange is taxable, and in a simple trade tax is due on the deed for each property.⁵

What the numbers look like in Anne Arundel County. The county recordation tax is $7.00 per $1,000 of consideration, rounded up to the nearest $500, which is $3.50 per $500. The county transfer tax is 1.0 percent on transactions up to $999,999.99 and 1.5 percent on transactions of $1,000,000 or more.⁶ The State transfer tax of 0.5 percent applies on top.

On a $1,200,000 relinquished property and a $1,500,000 replacement property in that county, the taxes on the two deeds are approximately as follows.

How those amounts are divided between buyer and seller is a matter of contract. Absent a contrary provision, Maryland presumes that the parties intended to share the State transfer tax equally.⁷ The practical point is that more than $70,000 of conveyance taxes attaches to this pair of transactions whether or not the exchange succeeds, and none of it is deferred.

60.2 Parking arrangements and multiple transfers

The problem. Interposing an intermediary between the seller and the buyer can produce two deeds for each property: one into the intermediary and one out. A simple swap has two taxable instruments. A deferred exchange in which the intermediary takes title to both properties has four.

Maryland's answer, as reported. The Maryland practice guide describes the four legs as follows, relying on a memorandum of advice from an Assistant Attorney General to the clerks of the circuit courts.⁸

When the relinquished property is transferred from the taxpayer to the intermediary, the intermediary acts as the taxpayer's nominee, and the transfer is a zero consideration transfer.

When the relinquished property is transferred from the intermediary to its purchaser, the deed is taxable on the consideration paid.

When the replacement property is transferred to the intermediary, the intermediary acts as the taxpayer's nominee in purchasing it, and the deed is taxable on the consideration paid.

When the replacement property is transferred from the intermediary to the taxpayer, the deed merely transfers legal title from the nominee to the true purchaser, and it is a zero consideration transfer.

The result is two taxable instruments, the same as an ordinary sale followed by an ordinary purchase. The intermediary's presence does not add tax.

Two cautions about that source. The guide states on its face that no one in the Attorney General's office participated in its preparation and that it should not be cited as legal authority.⁹ It is a reliable description of how clerks have been advised to handle exchanges, and it is not a substitute for confirming treatment with the clerk before closing. In addition, in most forward exchanges today the deeds run directly from the taxpayer to the buyer and from the seller to the taxpayer under the assignment and direct deeding rules of 24.3 and 24.4, so the zero consideration legs never appear as recorded instruments. The nominee analysis matters most where the intermediary actually takes title, which in modern practice means the reverse exchange.

The final step of a Maryland reverse exchange. A Maryland firm has advised that the exchange accommodation titleholder's transfer of the replacement property to the taxpayer at the end of a reverse exchange is exempt from State and local recordation and transfer taxes, whether it is made by deed or by assigning the membership interests of the limited liability company that holds title. The analysis treats the titleholder as a straw man conveying to the true beneficial owner, and cites opinions of the Attorney General and an Assistant Attorney General's letter addressing that step.¹⁰ That letter is dated October 24, 2004 in the firm's description, while the practice guide cites a memorandum dated October 28, 2004; they may be the same advice or two related documents, and the original should be obtained before it is relied on.

For the assignment route, the controlling interest provision supplies the link: a transfer of a controlling interest in a real property entity is not subject to recordation tax if a transfer of the real property by deed between the same parties and under the same circumstances would have been exempt under the general exemption statute.¹¹ The controlling interest regime itself was enacted in 2007, reaches transfers of more than 80 percent of the equity interests in a real property entity, is extended to the transfer taxes by a companion provision, and is implemented by regulations of the Department of Assessments and Taxation.¹²

Pennsylvania's opposite answer. Pennsylvania's Department of Revenue states that in a multiparty exchange the interposed intermediary or titleholder requires two transfers to convey the property, and that multiparty deferred exchanges can therefore result in multiple impositions of tax on the same property.¹³

It rejects the argument that the intermediary or titleholder is an agent or straw party entitled to the exclusion for transfers from an agent or straw party to its principal.¹⁴ The reasoning is federal. An exchange cannot occur if the taxpayer owns both the relinquished and the replacement property at the same time. If ownership held by an intermediary or titleholder could be imputed to the taxpayer, as it would be in an agency or straw relationship, the taxpayer would own both properties and there would be no exchange. Federal law therefore precludes the intermediary or titleholder from being the taxpayer's agent or straw party, and the Department cites the regulation providing that a qualified intermediary is not the taxpayer's agent and the revenue procedure requiring the titleholder to hold qualified indicia of ownership.¹⁵

What the contrast teaches. Maryland, as reported, treats the intermediary as a nominee for conveyance tax purposes and so avoids a second tax. Pennsylvania treats the same intermediary as a genuine owner because federal law requires that characterization, and so taxes both legs. Each position is internally coherent, and they describe the same person in opposite terms.

Two practical consequences follow.

In Pennsylvania, use direct deeding in forward exchanges wherever the transaction permits, so that the intermediary never takes title, and price a second transfer tax into any reverse exchange.

In Maryland, confirm with the clerk before closing that the zero consideration treatment will be applied, and do not try to support it by describing the intermediary as the taxpayer's agent in the exchange documents. That description is the one federal law forbids, as 29.3 develops, and the conveyance tax result should be obtained through the clerk's accepted treatment rather than by recharacterizing the intermediary in the agreement that makes the exchange work.

60.3 Exemption architecture

Maryland has no exemption named like-kind exchange. The results in 60.2 come from the measurement of consideration and from the treatment of a nominee, not from an enumerated exemption. That makes the Maryland result depend on the facts of each leg and on clerk practice, which is a reason to confirm it in advance rather than assume it.

The enumerated exemptions. The recordation tax exemptions are collected in one statute. The State transfer tax statute imports a list of those recordation tax exemptions, including transfers to governmental units, transfers between specified relatives and domestic partners, transfers between spouses and domestic partners, supplemental instruments, and previously recorded instruments, and adds exemptions of its own.¹⁶ The controlling interest provisions apply the same exemptions to transfers of entity interests.¹⁷

County transfer taxes do not all follow the State. A county transfer tax imposed by a code home rule county does not apply to an instrument that is exempt from the State transfer tax. A charter county, by contrast, may impose and limit its county transfer tax within the bounds of its charter, and Anne Arundel County is a charter county.¹⁸ A State exemption therefore does not automatically carry to an Anne Arundel County transfer tax, and the county's own law must be checked.

The first-time home buyer rate does not reach exchange property. The State transfer tax rate is reduced to 0.25 percent, payable entirely by the seller, for improved residential property sold to a first-time Maryland home buyer who will occupy it as a principal residence, and the Maryland practice guide reports advice that the reduction is unavailable where the property will be used for another purpose.¹⁹ Replacement property in an exchange must be held for business or investment use, as Chapter 12 requires, so the reduced rate does not apply to it.

Pennsylvania's architecture turns on a single exclusion for transfers from an agent or straw party to a principal, and the Department's position in 60.2 is that intermediaries and titleholders are outside it.

The instruction that closes this chapter is budgetary. Conveyance taxes come out of the settlement statement at both closings, they are not deferred, and they reduce the cash that can be reinvested unless the client pays them from outside funds. A taxpayer who plans an exchange to the dollar, without accounting for them, will find a shortfall at the replacement closing, and Chapter 34 explains what a shortfall becomes.