Transfer Taxes Lurk in New York Foreclosure and Deed-in-Lieu Transactions: Part 1 of 2
It has become apparent that it is just a matter of time before the impact of the COVID-19 pandemic on the ability of commercial property owners to satisfy their mortgage (and mezzanine loan) debt obligations will lead to a considerable increase in foreclosures and deeds-in-lieu of foreclosures (or assignments-in-lieu of foreclosures, in the case of mezzanine loans). Certainly, not all debt-burdened commercial properties will be viable candidates for long-term loan workouts and modifications, and not all property owners will be able or willing to invest the additional equity that will be necessary to refinance or restructure the existing debt. Accordingly, whether as a result of the lender’s or the borrower’s business decision, or both, the “keys to the property” will be turned over by the owner at foreclosure or by conveyance-in-lieu of foreclosure.
In New York State, among the costs incurred in connection with a mortgage foreclosure or deed-in-lieu of foreclosure, or in the case of a mezzanine loan, a foreclosure under the Uniform Commercial Code or an assignment-in-lieu of foreclosure, are real property transfer taxes. These taxes can easily be overlooked, especially since there has been minimal foreclosure activity in New York during the eight-year period preceding the pandemic. In addition, the calculation of “consideration” in connection with the foreclosure or conveyance, upon which applicable transfer taxes are assessed, is certainly not straightforward. Moreover, particularly with respect to properties located in New York City, the amount of transfer taxes can be substantial.
In this two-part series, we will address the complexity of the rules governing the calculation of real property transfer taxes in New York in such a foreclosure or “in-lieu” transaction. This first part focuses on the calculation of real property transfer taxes in connection with a mortgage foreclosure and a deed-in-lieu of foreclosure. In part two of the series, we will turn our attention to the calculation of real property transfer taxes in connection with a UCC foreclosure of a mezzanine loan and an assignment-in-lieu of foreclosure.
Summary of Applicable Laws
Article 31 of the New York State Tax Law imposes a real estate transfer tax (the “State Transfer Tax”) on each conveyance of real property or interest in real property if the consideration exceeds $500, with the tax being computed at the rate of $2 for each $500 of consideration (or a fractional part thereof) (N.Y. Tax Law § 1402(a)). Similarly, Title 11, Chapter 21 of the City’s Administrative Code (§ 11-2102(a)(9)(ii)) imposes a real property transfer tax (the “City Transfer Tax”) on each conveyance of real property or interest in real property if the consideration exceeds $25,000, with the tax rate for commercial property being 1.425% where the consideration is $500,000 or less and 2.625% where the consideration is above $500,000.
For purposes of both the State Transfer Tax and the City Transfer Tax, a “conveyance” includes a conveyance pursuant to a mortgage foreclosure or a deed-in-lieu of foreclosure (N.Y. Tax Law § 1401(e); see N.Y.C. Admin. Code § 11-2102).
[NOTE: The State Transfer Tax and the City Transfer Tax are not imposed when the foreclosure or deed-in-lieu of foreclosure is consummated under a Chapter 11 plan pursuant to the federal bankruptcy code. Given how real estate loan transactions have been structured (e.g., with single purpose borrowers, bankruptcy remote protections, springing guarantees for bankruptcy filings), the ability of a borrower to be voluntarily or involuntarily placed in bankruptcy and have a foreclosure or deed-in-lieu of foreclosure consummated under a Chapter 11 plan is limited to specific and atypical circumstances.]
Calculation of “Consideration” for the Purposes of Calculating Transfer Taxes
In a mortgage foreclosure or deed-in-lieu of foreclosure, the calculation of the “consideration” under the applicable rules and regulations, upon which the applicable tax rate will be applied in order to calculate the State Transfer Tax and the City Transfer Tax, is neither simple nor logical; and the amount of transfer tax exposure could have a material impact on the parties’ decision on how to best structure the transfer of a property from a borrower to its lender or to pursue a foreclosure.
Set forth below is a summary of the calculation of consideration upon which the State Transfer Tax and, if applicable, the City Transfer Tax will be assessed for a mortgage foreclosure or a deed-in-lieu of foreclosure:
Foreclosure of Mortgage:
State Transfer Tax:
Where the grantee is the mortgagee (or its agent, nominee or an entity wholly owned by such mortgagee), consideration is the higher of:
- The sum of:
- the price paid by the grantee (the bid price) and
- the total amount of other liens or encumbrances remaining on the real property after the conveyance, whether the underlying indebtedness is assumed or taken subject to, or
- The sum of:
- the amount of the judgment of foreclosure and
- the total amount of any other liens or encumbrances remaining on the real property after the conveyance, whether the underlying indebtedness is assumed or taken subject to.
EXAMPLE 1: The mortgagee forecloses on its mortgage (which is non-recourse) and takes title to the property at foreclosure, and following the foreclosure there are no liens that remain on the property. The amount of the judgment is $600,000 and the mortgagee bids $300,000 at the foreclosure auction. Consideration for State Transfer Tax purposes is deemed to be $600,000.
However, if the mortgage debt is fully-recourse, then consideration is capped at the fair market value of the property (20 NYCRR § 575.11(a)(3)(i)).
[NOTE: Debt is recourse to the extent that, as of the date of conveyance, the grantor or a person related to the grantor including any guarantor, bears the economic risk of loss for the debt beyond any loss attributable to the value of the property securing the debt (see 20 NYCRR § 575.11(a)(2)(ii)).]
EXAMPLE 2: A mortgagee forecloses on its second mortgage lien, which is fully-recourse to the borrower, and takes title to the property at foreclosure subject to the first mortgage lien. The amount of the judgment is $400,000, the first mortgage lien on the property after foreclosure is $650,000, the fair market value of the property is $800,000, and the mortgagee bids $200,000 at the auction. The bid price ($200,000) plus the remaining liens ($650,000) equals $850,000, and the judgment ($400,000) plus the remaining liens ($650,000) equals $1,050,000. Because all of the debt is recourse, consideration is capped at the fair market value ($800,000).
Where the grantee is not related to the mortgagee ((i.e., a bona fide third-party bidder), consideration is (i) the amount actually paid by the successful bidder plus (ii) the total amount of any other liens or encumbrances remaining on the real property after the conveyance, whether the underlying indebtedness is assumed or taken subject to (20 NYCRR § 575.11(a)(3)(ii)).
[NOTE: The grantee is related to the mortgagee to the extent that the mere change of identity or form of ownership exemption in Section 1405(b)(6) of the New York State Tax Law applies to a conveyance by the mortgagee to the grantee (see also 20 NYCRR § 575.10). Where the grantee is partially related to the mortgagee, consideration will be subject to certain proportional application of the rules referenced herein applicable to the grantees related to the mortgagee and the grantees unrelated to the mortgagee (see 20 NYCRR § 575.11(a)(3)(iii)).]
City Transfer Tax:
Consideration is the sum of:
- The amount bid for the property,
- Senior liens not canceled by the sale, and
- Advertising expenses, taxes, and other costs paid by the purchaser (19 RCNY § 23-03(d)(2)).
EXAMPLE 3: A mortgagee forecloses on its mortgage lien on a commercial property in New York City. There are no other liens on the property after foreclosure, the judgment is in the amount of $700,000, accrued real estate taxes of $35,000 and advertising expenses of $6,000 are paid by the winning bidder, and the mortgagee bids $575,000 at the foreclosure and takes title per the foreclose auction. Consideration is deemed to be $616,000, which is the amount bid for the property ($575,000) plus other costs paid by the purchaser ($35,000 + $6,000 = $41,000).
[NOTE: Whether (a) the bidder is the mortgagee (or related to the mortgagee) and (b) the mortgage is recourse or non-recourse to the borrower is irrelevant for purposes of calculating consideration for the purposes of the City Transfer Tax.]
Deed-in-Lieu of Foreclosure of Mortgage:
State Transfer Tax:
Consideration is the sum of:
- The unpaid balance of the debt secured by the mortgage,
- The total amount of any other surviving liens and encumbrances remaining on the property after the deed-in-lieu transaction, and
- Any other amounts paid by grantee (not including state or local transfer taxes paid by grantee in connection with the conveyance, unless grantee contractually assumed the liability for the payment of such taxes or released its right to seek recovery of the payment from the grantor) (20 NYCRR § 575.11(a)(2)(i)).
However, if the mortgage debt is fully-recourse, then consideration is capped at the fair market value of the property plus any other amounts paid by the grantee pursuant to subsection (c) (20 NYCRR § 575.11(a)(2)(ii)).
EXAMPLE 4: A mortgagee enters into a deed-in-lieu of foreclosure of a mortgage securing outstanding debt of $950,000, with the property being subject to a $50,000 unpaid mechanic’s lien, $3,500 in unpaid water and sewer charges and a $1,500 judgment lien. The property has a fair market value of $800,000, and the mortgagee has not agreed to pay transfer taxes.
If debt is non-recourse, consideration equals $1,005,000 ($950,000 + $50,000 + $3,500 + $1,500).
If debt is recourse, consideration equals $800,000 (i.e., the fair market value).
City Transfer Tax:
Consideration is the sum of:
- The amount of the outstanding debt secured by the mortgage, and
- Any liens or encumbrances remaining on the property after the transfer (19 RCNY § 23-03(d)(1); see also John M. Zizzo, Bonnie A. Neuman & Michael J. Berey, Transfer Taxes on the Enforcement of Mezzanine Loans, 2009 N.Y. Law Journal).
In the second part of the series, we will turn our attention to the calculation of transfer taxes in connection with a UCC foreclosure of a mezzanine loan and an assignment-in-lieu of foreclosure.
For more information on the topic discussed, contact:
- Robert E. Helpern | email@example.com | 212-508-6720
- Eric S. Schoenfeld | firstname.lastname@example.org | 212-508-6713
- Neil E. Botwinoff | email@example.com | 212-508-6708
- David S. Handsman | firstname.lastname@example.org | 212-508-6786
- Ari Davis | email@example.com | 212-508-6796
- James A. Patalano | firstname.lastname@example.org | 212-508-6735
- Tyler F. Starr | email@example.com | 212-508-6712
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