The Appellate Court of Illinois, First District, recently concluded that the City of Chicago’s real property transfer tax did not extend to assignments of mortgages because, contrary to the City’s arguments, mortgage assignments are not beneficial or controlling interests in property.  The Court’s decision in City of Chicago v. Elm State Property LLC and Halsted West LLC addresses a scenario in which lenders frequently found themselves during the recession and its aftermath, and also illuminates a potential defense for mortgagees in other jurisdictions where transfer tax is not explicitly applicable to mortgage assignments.

 

The City of Chicago imposes a tax on “the privilege of transferring title to, or beneficial interest in, real property located in the city.”  The ordinance defined “beneficial interest in real property” to include, but not be limited to, (1) the beneficial interest in an Illinois land trust, (2) the lessee interest in certain long-term ground leases, and (3) the indirect interest in real property as reflected by a controlling interest in a real estate entity.  The City’s transfer tax, and its definition of beneficial interest, mirror a similar imposition at the state level under the Illinois Real Estate Transfer Tax Law.

In this case, defendants Halsted West LLC and Elm State Property LLC purchased loans and were assigned mortgages to real estate located in Chicago.  In both instances, the City sent the defendant an assessment for unpaid transfer taxes, alleging that the mortgage assignment constituted an assignment of a beneficial interest.

A trail of mortgage defaults in the recession’s wake

In 2007, 1950 North Halsted LLC entered into a mortgage loan purchase and sale agreement with a bank, and financed the purchase by taking out a loan for $5.3 million, secured by a mortgage on real property in Chicago’s Lincoln Park neighborhood.  1950 North Halsted subsequently defaulted on its mortgage obligations, and in 2009 the bank sold its loan (and assigned its mortgage securing the loan) to defendant Halsted West.  In 2010, the mortgagor executed a deed in lieu of foreclosure (DIL) transferring title of the property to Halstead West.  Because deeds filed in lieu of foreclosure are exempt from the transfer tax, the parties jointly filed a property transfer tax declaration indicating that the transaction was exempt.

Similarly, in 2006, Elm State LLC took out a $10.5 million bank loan, secured by a mortgage on real property in Chicago’s Gold Coast neighborhood.  Elm State LLC also executed an assignment of rents providing that, in the event of default, the lender had the right to collect rents, but could only apply those rents to the costs of maintaining the property, with the remainder applying towards the debt it was owed.  In 2009, Elm State LLC defaulted on the loan, and the original lender sold all of its “right, title, and interest in the Elm State Loan” to defendant Elm State Property LLC, and assigned the related loan documents.  In 2010, Elm State LLC executed a DIL transferring ownership of the property to Elm State Property LLC.

In both cases, the city sent each respective mortgagee a tax assessment for the assignment transactions, which the defendants protested before the City’s Department of Administrative Hearings.  The administrative law judge ruled in favor of each defendant, finding that the assignment of a mortgage does not convey a beneficial interest in real property, and that the transfers of the DILs were covered by an exemption.  The City appealed to the circuit court, which reinstated the tax.  The trial court’s decision was appealed to the Appellate Court, with the sole issues being (1) whether the assignments of mortgages constituted transfers of beneficial interests, and (2) whether the assignments fall under an exemption even if they do transfer a beneficial interest.

The Court found no support for the City’s interpretation

The City argued that the transfer tax applied to the assignment of the mortgages to the defendants because a mortgage is a beneficial interest in real property; logically, then, the assignment of a mortgage would be a taxable transfer.  But the Court found that the City’s interpretation went against every understanding of the term beneficial interest.  Generally, the Court found, a beneficial interest relates to the party having ownership control over the property.  A beneficial interest represents a form of equitable ownership and includes the interest of one who is in possession of all characteristics of ownership other than legal title.  Thus, the holder of a beneficial interest is the “effective owner” of the property even though it does not possess legal title.

In contrast, mortgages do not convey an equitable ownership in real property, and instead create only a lien on the property.  Although a mortgage gives the mortgagee a lien interest in property (which is beneficial), the Court encountered no authority that considered a mortgage a beneficial interest in real property.  Therefore, the Court held that the assignment of a mortgage is not a transfer of a beneficial interest in real property.

The City pointed to the ordinance defining beneficial interest and argued that, while an assigned mortgage was not included as a listed example, the definition was “not limited to” items on the list.  But the listed types of beneficial interests are all forms of ownership of the property, demonstrating the key elements of ownership: control and the right to enjoy the benefits of the property.  “The conspicuous lack of reference by authorities to a mortgage as a beneficial interest in real property, the fact that the listed beneficial interests all indicate a degree of ownership control, and the fact that a mortgage does not grant control over property” led the Court to conclude that a mortgage is not a beneficial interest in real property.

The City also argued that because the loans were already in default at the time the mortgages were acquired, the assignment actually conveyed a beneficial interest due to the mortgagee’s ability to collect rents and take possession of property upon foreclosure.  The problem with the City’s “novel line of reasoning,” said the Court, is that the collection of rents provisions are simply a form of security for the repayment of the loan, and the availability of remedies to a mortgagee does not make the mortgagee the owner or controller of the property.  Instead, such a clause simply grants an equitable lien as additional security for the mortgage.  The fact that the defendants were still required to acquire title to the properties through DILs demonstrated the lack of control they had with only a mortgage’s security interest in the property, even when the mortgages were in default.

Moreover, the remedies available to the mortgagees can be extinguished by the mortgagor simply curing the default or paying off the mortgage, in which case the mortgagor has no control or rights in the property.  Even under federal law, a mortgage is seen as a security interest and not an equitable interest.  Accordingly, the Court held that the assignment of a mortgage in default does not convey a beneficial interest in real property, and the City could not assess a tax on the mortgage assignments to the defendants.

Ultimately, the Court did not find it necessary to resolve the issue of whether mortgage assignments also fall under other exemptions within the transfer tax because the mortgages were not taxable interests under the transfer tax to begin with.  Accordingly, the Court reversed the ruling of the trial court and reinstated the ALJ’s decision finding Elm State Property’s and Halsted West’s mortgage assignments not subject to the City’s transfer tax.