Settlement Considerations on Acquisitions of DC Commercial Property – Plan Early and Keep Lines of Communication Open Between Settlement Company and Lender

The settlement process on commercial transactions and, more particularly, the completion of the FP7/C (Real Property Recordation and Transfer Tax Form) is markedly different than residential transactions. One particular pitfall has recently come to light that has plagued and delayed some transactions and has resulted in more money being due for recordation taxes than the buyer or lender had anticipated. Planning at the early stages of the loan and settlement processes may work towards everyone’s advantage.

By way of background, effective October 1, 2019 and expiring on September 30, 2023, the District increased the rate of transfer and recordation taxes on improved or unimproved commercial property (Class 2) if the actual or imputed consideration is greater than $2 million. The Office of Tax and Revenue issued OTR Tax Notice 2019-05 to provide general information.

The new rates also apply to mixed-use properties if any portion of the property is classified as Class 2, except in rare situations where a homestead deduction has been granted. The new rate imposes a surcharge so that transfer and recordation taxes are each at 2.5%.

Of interest here is calculation of the tax on deeds of trust. In short, there is a recordation tax to be collected on any amount of the deed of trust that is not exempt. For the purposes of calculating the $2 million threshold for deeds of trust, all debts recorded on the same day, as to the same property, are aggregated and, if threshold is met, the additional tax applies to all deeds of trust.

Keep in mind that, apart from transfer taxes on acquisitions, there is a recordation tax on the deed and a separate recordation tax on the deed of trust, although there may be some applicable exemption. Focusing on the recordation tax on the deed of trust, Part H asks for the “Purchase Money Amount” of the deed of trust to determine the dollar amounts of the deed of trust that are exempt from the recordation tax.

The field “Purchase Money Amount” is crucial. It seeks to elicit from the lender, what portion of its deed of trust is attributable to the acquisition price (as opposed to loan proceeds to be used for construction or other expenses). Only the “purchase money” component would be exempt. See DC Code §42-1102 which provides:

The deed of trust, on its face, needs a recitation as to the amount of the purchase money it is securing. See DC Code §42-1103(b-1)(2)(D) which provides:

The loan process should begin with an agreement between the lender and the borrower as to what portion of the deed of trust will be attributed to purchase money. The borrower would want that number to be higher, in order to take advantage of the exemption for purchase money.

The lender’s preference may be consistent because of the added legal protections for purchase money security interests.

The settlement company needs to keep the lender and the borrower informed. The lender must supply the purchase money dollar amount so that the settlement sheet can be calculated. The lender also needs to insure that the requisite language is printed on the deed of trust (by the way, that applies to all deeds of trust involving purchase money) and the dollar figure in that language must conform to the FP7/C.

If the settlement company does not focus on this element, there may be significant delays in trying to record the commercial deed of trust and the borrower may end up needing to bring more money to the table than anticipated for recordation taxes.

The most current version of the FP7/C must be used (at press time, the version is 08/2019). If the deed of trust is simultaneous with the acquisition, a single FP7/C may be used to record the deed and the deed of trust. Otherwise, a separate FP7/C must be filed for each deed of trust.

This summary is not intended to contain legal advice or to be an exhaustive review. If you have any questions about this case or laws impacting real estate in and around the Washington, D.C. region, feel free to contact us. Our Real Estate Litigation and Transactions Practice Group is ready to assist.