Desperate times driving desperate measures in some California county recorders' offices

By Maura O'Connor

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California’s perennial budget problems have been wreaking havoc in ways large and small across the state for some time now; the New Year does not look like it's going to get easier soon.  Fees and charges for all sorts of government activities are invented, and change their rules, imposing new obstacles to doing business just at the time when we should be making business easier. 

In our real estate market, one traditional struggle we face, when doing a deal, is figuring out and paying the required documentary transfer taxes, which are collected by country recorders.  This surcharge has never been popular with real estate professionals, but lately it's become even more of a problem, particularly for a class of transaction that is poignantly important in 2012:  deeds-in-lieu that surrender mortgaged property to the lender, in course of a workout or credit termination. 

In California, documentary transfer tax is ordinarily required whenever a property is conveyed.  (Mechanically, the amount of documentary transfer tax is typically stated on the face of the deed, or a separate statement, and the reasoning behind that amount is spelled out in a Preliminary Change of Ownership Report.)  This tax can amount to a substantial sum, as such taxes may be charged both at the county and at the city level, and may total up to $5.00 or $6.00 per thousand dollars of value of the property conveyed. 

"Deeds in lieu of foreclosure", of course, are consensual givebacks where the borrower hands back the property's keys and title to the lender, if a real estate-secured troubled credit can't otherwise be worked out.  Normally, documentary transfer tax is not charged when these deeds in lieu of foreclosure is recorded, because the borrower's deed ought to fall within the exemption, in Cal. Revenue and Taxation Code Section 11921, for reconveyances of realty upon satisfaction of a debt.  This transfer tax exception for workout deeds-in-lieu is mirrored in the laws of a number of other jurisdictions as well.

It also makes sense because the tax or fee is intended is supposed to be based on value received, and, in a typical deed-in-lieu takeback, the value of the surrendered property is less than or equal to the amount of the loans still encumbering it.  (Equal to, if the deed- in-lieu transaction effects the transfer of the property from the borrower to the lender’s designee but keeps the loan in place; usually less than, if the property is granted to the lender in exchange for forgiveness of the debt.) 

Either way, the lender's not really getting back any new value, so what is there to tax?  Unfortunately, cash-strapped county recorders don’t always see it that way today.   It appears that some recorders’ offices are under so much pressure to collect documentary transfer taxes that they're bending the rules, to push for payment of transfer taxes in deed-in-lieu transactions even though the relevant rules should prohibit it.

One sticking point can be the name of the deed instrument.  Some borrowers wish to give their properties back to their lenders in a consensual deed-in-lieu, but for various reasons may not want to have those deeds conspicuously titled “deed in lieu of foreclosure”.  In other cases, the borrower may be willing to give a deed back, in lieu of foreclosure, and surrender the property … but may wish to have the existing mortgage remain in place.  In those transactions, a lender might take title in a separate entity, which in some case may allow the lender to later eliminate junior liens through a later foreclosure, or to sell the property later to a third party subject to the existing financing. 

But these mildly creative deeds-back, taken in lieu of a foreclosure, may run into problems when the local recording authority won't grant the exemption to a recording tax unless the deed provided by the borrower is titled “Deed in Lieu of Foreclosure”.  At least in California, this is not a sensible position:  the state statute providing the exemption does not require use of particular words in the title for the deed.  However, since recorders have some discretion in electing whether to demand a transfer or recording tax up front, before recording the deeds, it often isn't practical to challenge their determination that a payment is required. 

So, to summarize:  (1) Tough times call for creative measures.  (2) Creative workouts may include a surrender of mortgaged property using some device that isn't called "deed in lieu".  (3) It still is one, though.  (4) Recorders may not want to believe that, if it means they get no transfer tax revenue.  (5) But they're the ones holding the recordation stamp, so this can be a tough argument for you, especially if you're trying to record and close a deal. 

One potential way around this is to comply with the transfer tax, but cannily.  Instead of insisting on the exemption for reconveyances of realty in satisfaction of a debt, in cases where a complex or oddly-named structure may make the recorder balk, the lender who is taking a deed-in-lieu can instead declare documentary transfer tax due on the basis of the current value of the property LESS the amount of the lien remaining in place.   (California Revenue and Taxation Code Section 11911 provides that documentary transfer tax may be charged only when “when the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale) exceeds one hundred dollars ($100) . . . .”).  Typically, by that calculation, the amount of documentary transfer tax due will be zero.  This approach often works in California, although it requires a showing of the current value of the property (required under the Preliminary Change of Ownership Report required to be filed with the deed in lieu).

For example, if a deed in lieu is given pursuant to a loan where the original loan amount was $25,000,000, and the property securing the loan was originally valued at $30,000,000 and is currently valued at $15,000,000, the documentary transfer tax should be calculated on the current value of the property collateral ($15,000,000) less the amount of the loan ($25,000,000). You will include the transfer tax declaration – but showing the negative value.  Since the resulting amount would be less than zero, in that example, no documentary transfer tax should be due upon the recording of the deed in lieu pursuant to California Revenue and Taxation Code Section 11911.   

The most aggressive county recorders' offices, in their scrambles for funds, may insist on relying on the last assessed value of the properly conveyed,  as the only value they allow for the calculation of the documentary transfer tax due on it.  Obviously, such older values are typically significantly out of date and also much higher than current values.  So far, we have been able to get that tougher breed of county recorder to accept our newer valuations by presenting a current broker opinion of value or appraisal, along with a legal argument.  Of course, presenting a BOV or appraisal and arguing it adds to the cost, time needed and complexity of what should be a relatively simple transaction.  Why is that additional cost, delay and complexity justified? 

Simply put, the lender taking a deed-in-lieu, and not relying on a deed in lieu exemption like that of California's Revenue and Taxation Code Section 11911, above, needs to state the amount of documentary transfer tax due.   While simply restating the most recent assessed value might speed up the recording process for a deed in lieu, your doing so could be used by the county recorder and, more importantly, the county tax assessor, to estop the lender (as owner) from later seeking to have the property reappraised for a lower value.  So this small detail, in a straightforward deed-in-lieu deal, if overlooked in the rush to get the deed recorded, can create later havoc for the lender in the form of needlessly higher property tax assessments. 

In the current environment, where commercial real estate values have fallen greatly, and many folks in our industry are trying to put the market back together again on a sustainably repriced basis, this sort of move by strapped governmental units strikes me as a sneaky and unjustified way to skim more money out of transactions with little or no upside value.  

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