Authors: Meghan O’Reilly and Rachel M. Orbach
On January 13, 2020, Senator Julia Salazar and Assembly Member Harvey Epstein introduced a new bill in the New York State Legislature that proposes to require the payment of mortgage recording tax in connection with mezzanine debt (i.e., debt secured by the equity interests in an entity which owns real property) at the time of recording a related mortgage. The bill defines mezzanine debt as “debt carried by a borrower that may be subordinate to the primary lien and/or common shares and reported as assets for the purposes of financing such primary lien.” The proposed bill would require that taxes collected from this new recording tax be used specifically to fund public housing. This new tax would increase the cost of mezzanine financing for New York property owners and potentially lead to changes in financing structures for lenders and developers.
There are a number of technical questions which would require additional clarification if such a tax were to become operational. First and foremost, the definition of mezzanine debt is broad and unclear. Mezzanine debt has been traditionally understood as debt that is secured by the direct or indirect equity interests in a property owner. The legislation’s proposed definition of mezzanine debt may inadvertently capture corporate, tax structuring, debt secured by co-op interests and other financing which is not mezzanine debt as the market understands it.
In addition, the legislation requires that the mezzanine debt relating to a property be “filed” in connection with the recording of a mortgage on such property at the county level. Currently, the only filing made with respect to a typical mezzanine loan is a Uniform Commercial Code Financing statement at the state level and requires information which may be different from mortgage filings. Further, mezzanine debt may or may not be incurred at the same time as a mortgage. The current wording of the statute leaves open the possibility that filings and payments of the related tax would only be required at the time a mortgage was filed on the property. If this is permitted under the final wording of the statute, it would be easy enough to stagger the timing of all or any portion of the mortgage loan and the mezzanine loan so as to avoid this additional tax.
More important than the technical problems with the new legislation are the public and tax policy considerations underlying a new tax of this type. In the event that tax revenue is needed for public housing purposes, it is unclear why imposing a tax on mezzanine debt, a tax that will be passed on to all consumers, is the appropriate mechanism for raising such funds. Further, it is reasonable to assume that, in reaction to this legislation, the market will restructure what would otherwise be mezzanine debt as preferred equity. In that case, arguably the incremental risk involved in structuring debt as equity, even with the most conservative terms possible, has the potential of increasing the cost of financing real estate. This would have the unintended effect of increasing rental costs and a potential chilling effect on new construction, in each case, including for housing. As a result, the costs to pay for the increased taxes could trickle down to New York residents renting or buying an apartment or businesses renting or purchasing office space in New York. Mortgage recording tax is an existing tax burden on real estate financing in New York and it is unclear why mezzanine debt, out of all the many types of commercial and consumer debt, is being arbitrarily singled out for additional taxation.
In the wake of recent legislative changes to rent regulatory control laws which have had unintended consequences for the market and which anecdotally may already have had a chilling effect on property sales in the market, it would be unwise for the legislature to pursue new mortgage recording tax initiatives without further detail and a full understanding of the market considerations involved.
We will keep you advised of the progress of the pending legislation.
