Understanding Maryland Non-Resident Withholding on Real Estate

In the past nine years of practicing law in Maryland, specifically real estate in Deep Creek lake I have become very familiar with the Maryland Non-Resident Withholding tax.

As a general matter, when you sell real estate and you realize a gain, absent the home being your principal residence that you owned for 2 of the past 5 years (see IRC 121 discussion below) or  a “1031 like-kind exchange”, you will need to pay both federal and state capital gains tax (the state rate depending on which state) on the gain. 

Maryland has 2 large vacation areas Deep Creek Lake and Ocean City, where a large proportion of the sellers tend to be out of state residents.

Maryland decided that, rather than relying on these out of state sellers to remember to file a Maryland State Tax Return for the year in which they sell real estate (to pay the state capital gains tax on the gain from the sale), they would reverse the burden and withhold an amount at closing intended to cover the capital gain tax. 

As of March 2016 this rate is 7.5% for individuals, 8.25% for non-resident entities (e.g. a Virginia LLC not registered to do business in MD). 

The test for whether one is a resident of Maryland is similar to that of the Federal Tax Code, i.e. they are presently domiciled in Maryland (a good indicator of this is to check the address that is listed as the mailing address for the property in SDAT’s records).  Note that it is not the title agent’s responsibility to report whether the seller is a resident or non-resident, it is the seller’s responsibility when they sign the Certification of Exemption From Withholding Upon Disposition of Maryland Estate Affidavit of Residence or Principal Residence wherein they affirm that they are a resident of Maryland. 

In addition, Maryland tracks IRC 121 which says that if someone lived in the property as their principal residence for 2 of the past 5 years , they are equally exempt from withholding. 

Its important to note that this is not a new or additional tax, just a reversal of when it is typically paid, and that it is only applicable when there is a gain.  In other words if the seller is selling at a loss (calculated by subtracting the adjusted cost basis (what they paid for the property, plus any improvements, less any depreciation), from the sales price, no state capital gains tax would be due. 

If there is no gain or so slight of a gain that the withholding rate would result in a refund being owed, the seller has 3 options:

  1. If they are within 21 days of closing, they may file form MW506AE, an Application for Certificate of Full or Partial Exemption http://forms.marylandtaxes.com/16_forms/MW506AE.pdf (the certificate would then be sent to the seller or title office showing that they are either fully exempt or eligible for a reduced withholding amount;
  2. If they miss the 21 day window they may,once 60 days have passed since the deed was recorded, file form MW506R, an Application for Tentative Refund of Withholding http://forms.marylandtaxes.com/15_forms/MW506R.pdf;
  3. If they fail to do either of the above, they may wait until the following year and file a Maryland State Tax Return for the year in which they sold real estate to receive their refund. 

More information can also be found here:  http://forms.marylandtaxes.com/current_forms/Withholding_requirement.pdf

As always individual circumstances may vary so I encourage you to consult your CPA regarding these potentially complex issues.

Posted on 15 March '16 by , under Blog.