April 27, 1994
Client Memo: Taxation of Deeds of Trust in the District of Columbia
Arnold & Porter Article
On April 14, 1994, Mayor Kelly signed into law a tax on the recordation of most commercial deeds of trust and mortgages in the District of Columbia. Because the law will not be effective until June 1, 1994, a window of opportunity now exists to close financing transactions prior to the imposition of the new tax.
The District of Columbia has long imposed a transfer tax and a recordation tax on deeds, each in the amount of 1.1% of the consideration for the deed. Instruments creating security interests in real estate -- whether deeds of trust, mortgages or financing statements -- have been exempt from both taxes. The only exception has been deeds of trust or mortgages securing construction financing, which are subject to the 1.1% recordation tax.
The Omnibus Budget Support Act of 1994 (D.C. Act 10-225) changes this landscape dramatically. The Act provides that deeds of trust and mortgages are subject to the 1.1% recordation tax, unless one of several limited exemptions applies. The Act does not affect the exemption of deeds of trust and mortgages from the transfer tax.
Scope of the Tax
The Act imposes a tax on the recordation of any instrument which creates a security interest in District of Columbia real estate. As a result, any deed of trust, mortgage or UCC financing statement covering fixtures will be subject to the tax. Though prior amendments to the recordation tax statute impose a tax on the transfer of a controlling interest in an entity which owns real estate, the Act does not appear to apply to the creation of security interests in entity interests. For example, a pledge of all of the partnership interests of a partnership owning District of Columbia real estate is not subject to the new tax.
Calculation of the Tax
The amount of the tax is generally 1.1% of the principal amount secured by the security instrument. However, where the security instrument is refinancing either a purchase money security instrument, or a security instrument which was subject to the new 1.1% tax, the tax is payable only on the excess financing proceeds. For example, if a property is encumbered by a $1 million purchase money deed of trust, and a refinancing loan of $1.2 million pays off the purchase money deed of trust and provides an additional $200,000 of loan proceeds, only the additional $200,000 is subject to tax.
Exemptions from the Tax
The Act provides three principal exemptions from the new tax. Purchase money deeds of trust and mortgages are expressly exempted from the tax, though there is some ambiguity as to what instruments satisfy this exemption. One section of the Act provides an exemption for a "purchase money mortgage or purchase money deed of trust that is recorded simultaneously with the deed conveying the real property for which the purchase money mortgage or purchase money deed of trust was obtained." However, another section of the Act requires that the purchase money security instrument "be recorded within 30 days after the date that the deed conveying title to the purchase of the real property is duly recorded." Additional technical requirements, relating to the form of the purchase money instrument, are imposed by the Act as well.
The Act also exempts the transfer of a note, and the transfer of a mortgage or deed of trust securing a note. The transfer and subsequent amendment of notes and security instruments has been an avenue for minimizing taxes in jurisdictions which impose stiff recordation taxes on new financing. The District's exemption appears calculated to prevent this, and specifically limits the exemption for transfer of notes and security instruments to transfers (i) which are "on the secondary market," (ii) where "there are no changes in the terms or conditions provided in the instrument," and (iii) where the borrower, "has taken no action to refinance." While the precision of this definition leaves much to be desired, it is clearly intended to prevent the assignment and amendment of an existing security instrument solely for purposes of avoiding the new tax.
Finally, the Act exempts security instruments encumbering Class 1 or Class 2 properties that contain no more than 5 dwelling units. These properties consist of owner-occupied single family homes, rental properties, and housing cooperatives used for these purposes. To qualify for this exemption, the owner must submit an affidavit stating that the property satisfies this test.
The District of Columbia has long imposed a transfer tax and a recordation tax on deeds, each in the amount of 1.1% of the consideration for the deed. Instruments creating security interests in real estate -- whether deeds of trust, mortgages or financing statements -- have been exempt from both taxes. The only exception has been deeds of trust or mortgages securing construction financing, which are subject to the 1.1% recordation tax.
The Omnibus Budget Support Act of 1994 (D.C. Act 10-225) changes this landscape dramatically. The Act provides that deeds of trust and mortgages are subject to the 1.1% recordation tax, unless one of several limited exemptions applies. The Act does not affect the exemption of deeds of trust and mortgages from the transfer tax.
Scope of the Tax
The Act imposes a tax on the recordation of any instrument which creates a security interest in District of Columbia real estate. As a result, any deed of trust, mortgage or UCC financing statement covering fixtures will be subject to the tax. Though prior amendments to the recordation tax statute impose a tax on the transfer of a controlling interest in an entity which owns real estate, the Act does not appear to apply to the creation of security interests in entity interests. For example, a pledge of all of the partnership interests of a partnership owning District of Columbia real estate is not subject to the new tax.
Calculation of the Tax
The amount of the tax is generally 1.1% of the principal amount secured by the security instrument. However, where the security instrument is refinancing either a purchase money security instrument, or a security instrument which was subject to the new 1.1% tax, the tax is payable only on the excess financing proceeds. For example, if a property is encumbered by a $1 million purchase money deed of trust, and a refinancing loan of $1.2 million pays off the purchase money deed of trust and provides an additional $200,000 of loan proceeds, only the additional $200,000 is subject to tax.
Exemptions from the Tax
The Act provides three principal exemptions from the new tax. Purchase money deeds of trust and mortgages are expressly exempted from the tax, though there is some ambiguity as to what instruments satisfy this exemption. One section of the Act provides an exemption for a "purchase money mortgage or purchase money deed of trust that is recorded simultaneously with the deed conveying the real property for which the purchase money mortgage or purchase money deed of trust was obtained." However, another section of the Act requires that the purchase money security instrument "be recorded within 30 days after the date that the deed conveying title to the purchase of the real property is duly recorded." Additional technical requirements, relating to the form of the purchase money instrument, are imposed by the Act as well.
The Act also exempts the transfer of a note, and the transfer of a mortgage or deed of trust securing a note. The transfer and subsequent amendment of notes and security instruments has been an avenue for minimizing taxes in jurisdictions which impose stiff recordation taxes on new financing. The District's exemption appears calculated to prevent this, and specifically limits the exemption for transfer of notes and security instruments to transfers (i) which are "on the secondary market," (ii) where "there are no changes in the terms or conditions provided in the instrument," and (iii) where the borrower, "has taken no action to refinance." While the precision of this definition leaves much to be desired, it is clearly intended to prevent the assignment and amendment of an existing security instrument solely for purposes of avoiding the new tax.
Finally, the Act exempts security instruments encumbering Class 1 or Class 2 properties that contain no more than 5 dwelling units. These properties consist of owner-occupied single family homes, rental properties, and housing cooperatives used for these purposes. To qualify for this exemption, the owner must submit an affidavit stating that the property satisfies this test.
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Absent a Congressional veto of the Act during the 30-day layover period, the new tax will apply to financing transactions on and after June 1st. If you would like a copy of the Act, or have questions concerning its applicability to a specific transaction, please call Michael Goodwin at 202/728-2282 or any other member of the Real Estate Practice Group.
