DC Sources New Revenue From Assignments of Long-Term Leases

On May 17, 2024, the District of Columbia Office of Tax and Revenue (OTR) published a notice summarizing the District of Columbia’s current policy regarding the recordation and transfer tax treatment of an assignment of a lease, including a ground lease, with a term of at least 30 years (including renewals). This is the first official statement by OTR regarding the taxation of assignments of long-term leases, including ground leases. This official policy changed an approximately 20+ years of practice (since the enactment of DC Law 13-305, June 9, 2001, amending the then existing recordation and transfer tax statutes in order to tax long-term leases) of the DC Recorder of Deeds, which did not tax assignments of ground leases or other long-term leases based on the rent charged. This new policy is strikingly different from the recordation and transfer treatment of assignments of long-term leases by the State of Maryland and the Commonwealth of Virginia. OTR also stated in its notice that it will impose recordation and transfer taxes (i) on extensions of leases that have a term of at least 30 years (presumably, leases that are not originally long-term but, as a result of an extension, have a term greater than 30 years), and (ii) to the extent there is a transfer of any real estate interests related to a transfer of real property.

OTR relied on a District of Columbia Court of Appeals decision made on July 20, 2023 (MEPT St. Matthews, LLC v. District of Columbia, 286 A.3d 1010), which, deciding a case of first impression, held in favor of OTR’s changed position that an assignment of a ground lease is taxable in the same manner as a newly created lease. Consequently, the District of Columbia is imposing recordation and transfer taxes based on the rent charged under long-term leases (i.e., those with an outstanding term or term of at least 30 years (including renewals)) plus the value of other consideration paid in addition to the rent (e.g., the value ascribed to any real estate, such as improvements, for which there is additional consideration paid). 

The primary result of the policy change is substantially higher recordation and transfer taxes on assignments of long-term leases than it had for the first 20 years of the District’s practice of taxing long-term leases. There will be at least two components of any recordation and transfer tax analysis in connection with the imposition of taxes: (i) the calculation of the taxes imposed on the rent being charged under the lease, and (ii) value of the improvements, if any, transferred and/or other additional consideration.

Rent Component

If the average annual rent under the lease is ascertainable, the transfer and recordation taxes are imposed upon the average annual rent over the term of the lease, including renewals, capitalized at a rate of 10%. DC Official Code §§ 47-903(a)(2), 42-1103(a)(1)(B)(i). If the average annual rent is not ascertainable, then the taxes are based on the greater of (1) 105% of the of the minimum average annual rent ascertainable from the terms of the lease, capitalized at a rate of 10%; or (2) 150% of the assessed value of the real property covered by the leasehold interest transferred. DC Official Code §§ 47-903(a)(3), 42-1103(a)(1)(B)(ii). If the consideration for the lease is zero or nominal, then the tax is applied to the fair market value of the real property covered by the lease. DC Official Code §§ 47-903(a)(1)(B), 42-1103(a)(1)(B)(iii). Since most if not all long-term leases provide for rent adjustments that are not fixed, such as adjustments made on the basis of increases in the CPI and/or periodic adjustments based on the fair market value of the leased premises, the average annual rent will be considered “not ascertainable” and, as such, be subject to having the rent determined by 150% of the assessed value of the leased premises. Note that the District will impose the taxes based on the “real property covered by the interest transferred” which the District maintains is the real property, land and/or improvements, subject to the lease and not the possessory interest in such real property. This is so notwithstanding that the tenant or ground tenant does not own the interest in the land that is retained by the landlord.

Additional Consideration

The District considers “additional consideration” to include any consideration paid or to be paid for the lease, whether in cash or other property, in any amount (exclusive of the rent component) and will be taxed based on the consideration paid for such interests, or, if the consideration is zero or nominal, on the fair market value of such interests.

Other Real Estate Interests

The District expressed its intention to impose recordation and transfer taxes on the transfer of real property interests pursuant to an assignment of a lease which is not a long-term lease (having a term or remaining term of less than 30 years). This is so despite no requirement that the lease be recorded. Rather, this follows a Court of Appeals decision in December 2022 in which the Court imposed recordation and transfer taxes on the value of reversionary interests in improvements constructed on land subject to a ground lease having a remaining term of less than 30 years (see District of Columbia v. Design Center Owner (D.C.) LLC, et. al., 286 A.3d 1010); the Appeals Court sent the matter back to the lower court to determine the value of such reversionary rights).