Thinking About Buying REO Property? Read This First!
Recently, the Seventh Circuit Court of Appeals held that an exemption for municipality transfer taxes in favor of Government Sponsored Enterprises (“GSE”), such as Fannie Mae and Freddie Mac, does not extend to third party purchasers. Federal National Mortgage Association, et al. v. City of Chicago. What does that mean for you as an investor in REO property? (REO just means the property is one that a bank or other lender has taken into its inventory following a foreclosure sale in which it does not sell to a third party – these properties are often available at deep discounts).
As you probably know, the City of Chicago imposes a Real Property Transfer Tax on the transfer of real property located within the city. As part of the transaction, the tax liability is typically divided between purchaser and seller. An exception to that general rule is when the seller is exempt from such payment based on a state or federal law. When a seller entity is exempt, the City requires the exempt entity’s portion of the tax to be paid by the purchaser. In recent years, it became common for purchasers who bought REO properties from GSEs to refuse to pay the taxes. As a result, the Illinois Department of Finance began fining the purchasers and demanding the tax and fine. Administrative judges upheld the fine in a series of administrative hearings, and thereafter purchasers sued the city in Federal court seeking review of the administrative decision. The District Court for the Northern District of Illinois held that the tax was preempted by the federal exemption statutes.
However, on appeal, the Seventh Circuit reversed the District Court’s decision and held that the GSE exemption of the transfer tax does not extend to third party purchasers. The Court looked to the GSE’s enabling statute that exempts them from the transfer tax and reasoned that nothing in the plain language of the statute states or implies that entities or individuals who transact with the GSEs are exempt from the tax. In other words, the Court refused to allow for the GSE tax exemption to pass-through to the buyers of the GSE properties.
The Court’s decision in Federal National Mortgage Association clears up some uncertainty that purchasers and lawyers were grappling with. It is now clear (unless an appeal is filed with the U.S. Supreme Court), that buyers of GSE-owned REO properties must pay the exempt entity’s portion of the Real Property Transfer Tax as well as their own. The decision also serves a solid warning to purchasers of REO properties - it is necessary to do some preliminary investigation to see if a prospective residence is a GSE-owned property. Prospective purchasers of GSE-owned properties should consult with counsel to understand the process and all associated liabilities.
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