The LLC loophole

February 27, 2004

LIMITED LIABILITY companies are smart business. LLCs and the similar LLPs (limited liability partnerships) were created as a hybrid between corporations and partnerships in the early 1990s to help shield small-business owners from personal liability. But a funny thing happened. Investors started taking advantage of a tax loophole. And now that loophole needs to be filled.

Here's the problem. Sometimes, LLCs are used purely as a way to invest in a piece of commercial real estate. That's fine. But when it's time to sell the property, the company is sold but the real estate title isn't transferred. There's no need. The company is still the owner. It's just somebody else who now owns the company.

By selling property in this backdoor manner, LLCs avoid transfer and recordation taxes - those niggling little closing costs of 1 percent to 2 percent that the rest of us deal with when we buy a home. Of course the difference is that with multimillion-dollar transfers, these costs aren't so petty. In Maryland, state and local governments lose out on about $44 million each year.

Fortunately, state House Speaker Michael E. Busch has offered a smart solution. He's proposed closing the loophole and funneling the proceeds into school construction. It's hard to argue with that. A recent task force found that Maryland needs to spend $2.85 billion over the next eight years to make schools "adequate" across the state.

Mr. Busch's plan wouldn't dissolve LLCs. It would simply require that owners of this type of LLC (that is, a pure real estate investment) voluntarily report real estate transfers to the state and pay the equivalent of the transfer taxes. Chances are, the owners wouldn't bother. They'd simply revert to selling property the way the rest of us do - by transferring title to the new owner and paying their fair share of taxes.

Naturally, commercial property owners and business groups aren't too wild about the idea. They see it as a new tax and claim the proposal is unworkable. But neighboring Pennsylvania, Delaware and the District of Columbia have successfully closed the loophole using a similar strategy. Now it's Maryland's turn.

With Mr. Busch's support, the House of Delegates is certain to pass the proposal. Gov. Robert L. Ehrlich Jr. hasn't taken a position on the issue, but he's unlikely to veto legislation that helps pay for school construction. That leaves it up to the state's senators to show real leadership on the budget - and not just be the folks who embrace slot machines every year.

Correction

In a Feb. 12 editorial, Howard P. "Buck" McKeon was misidentified. He is a U.S. congressman. The Sun regrets the error.

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