A matter of fairness

December 26, 2006

With the real estate market cooling and state and local government facing substantial budget deficits in the near future, the case for closing one of Maryland's most notorious tax loopholes has never been stronger. It's outrageous enough that the average person pays real estate recordation and transfer taxes while the average million-dollar-plus commercial property owner doesn't. But with the looming shortfall in tax revenue, giving a free pass to shopping mall and office park owners is beyond the pale.

Here's the problem. Since the 1990s, Maryland has allowed commercial property to be held in limited liability partnerships or corporations. The rationale behind this was quite reasonable. LLCs and LLPs were created as an affordable way to protect individual business investors from liability lawsuits.

But the law also allows property to be sold through a transfer of "controlling interest" instead of an outright title transfer. That saves the buyer 1 percent to 2 percent of the purchase price.

For the average homeowner, converting to an LLC wouldn't be worth all the legal fees. But for the owner of a $100 million commercial property, this is a potential $2 million tax windfall.

States and cities have been gradually closing the loophole. California, Connecticut, Delaware, Illinois, New York and Pennsylvania are chief among them. But the failure of such reforms in Annapolis is a tribute to the political influence of developers and the real estate industry. Legislation to close the LLC loophole has met with broad support in the House of Delegates but not with the Senate Budget and Taxation Committee, whose members have yet to approve any version of the bill.

That needs to change. The loophole is costly for Maryland's land conservation efforts (the state's portion of the transfer tax goes exclusively to Program Open Space). The loss of tax revenue is most keenly felt by local governments, which may be tempted to raise property taxes to cover future budget shortfalls. But at its core, this is a matter of equity - the law was never intended as a giant tax dodge.

Mayor Martin O'Malley endorsed LLC reform last year as a way to help finance public school construction in the future. As governor, he ought to make it a top priority. Not only is it good policy, but demonstrating that he's not beholden to big-time campaign contributors is good politics, too.

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