Reconsider Recording Leases

June 8, 2010

The high cost of recording leases in the District of Columbia, Maryland and Virginia, paired with the reluctance of landlords to encumber title, have been primary factors in many tenants’ decisions not to record a lease or a memorandum of lease in these jurisdictions. However, the new economic landscape may warrant a re-examination of such decisions in order to protect a party’s rights. The decision of whether or not to record a lease or a memorandum of lease will likely be based, at least in part, on an analysis of the costs associated with such recordation. Since the cost of recording varies by state, and sometimes by locality within a state, one may want to consider consulting an attorney licensed where the real estate is located prior to making a decision.

Recordation of Leases in the District of Columbia

Any lease may be recorded in the District of Columbia. Leases for terms of at least 30 years, including extensions, however, are subject to recordation tax. Pursuant to D.C. Code §42-1103, the Tax Clarity Act imposes the district’s steep recordation taxes on those recorded leases with terms in excess of 30 years, including all extensions or renewals. The computation of the tax is based on a number of fact-specific alternate determinations of the amount of rent paid during the term of the lease. For example, rent paid might be calculated as the average annual rent over the term of the lease, including renewals, capitalized at a rate of 10 percent, plus any additional consideration payable, provided such amount does not exceed the fair market value of the real property covered by the lease. Leases for terms of fewer than 30 years are not subject to transfer or recordation taxes.

Recordation of Leases in Maryland

The general rule in Maryland is that leases for more than seven years must be recorded and that unrecorded leases with terms of more than seven years do not pass any legal estate to the tenant. See Md. Code Ann., Real Prop., § 3-101(a) (2003 Repl. Vol.). Nonetheless, due to the high cost of recording most leases, it is unusual to record a lease in the state of Maryland. Tenants, and often times their lenders, are able to get comfortable with not recording since Maryland law provides broad protection for the unrecorded lease. Executed but unrecorded leases of more than seven years are fully effective (i) between the original parties to the lease and their personal representatives, (ii) against their creditors, and (iii) against and for the benefit of any other person who claims by, through, or under an original party and who acquires the interest claimed with actual notice of the lease or at a time when the tenant, or anyone claiming by, through, or under the tenant, is in such actual occupancy as to give reasonable notice to the person. See Md. Code Ann., Real Prop., § 3-101(d) (2003 Repl. Vol.). Leases with an initial term not exceeding seven years are not required to be recorded so long as each renewal term under the lease (a) is for seven years or fewer, and (b) may be effected or prevented by a party to the lease or its assigns. See Md. Code Ann., Real Prop., § 3-101(c) (2003 Repl. Vol.). Leases that are not required to be recorded (that is, a lease of seven years or less) may be recorded without the imposition of taxes. See Md. Code Ann., Tax-Property, §§ 12-108(u) and 13-207(a)(14) (2007 Repl. Vol.).

Recordation of Leases in Virginia

Virginia law requires that a lease for a term of more than five years be recorded, or it is void as to all purchasers for valuable consideration without notice of the lease and not parties to the lease itself, and as to all lien creditors. In other words, if a tenant does not record its lease, or a memorandum of it, the tenant could lose the lease if the landlord sold the property to a purchaser who had no notice of the lease. While not a likely scenario, the mere possession of real estate is not in and of itself notice to purchasers for value of the existence of the leasehold estate. See §55-96(A)(1) of the Code of Virginia (1950), as amended. The statute does not allow long-term leases to be partitioned (i.e., dividing a lengthy term into segments). Therefore, a tenant cannot even hope to protect the first five years and void only that portion of the lease that extends beyond the five-year term.  See Watts Contrs., Inc. v. Watts (In re Watts Contrs., Inc.), 360 B.R. 489, 2007 Bankr. LEXIS 109 (Bankr. E.D. Va. 2007). The Supreme Court of Virginia has also held that a lease with an initial term shorter than five years, but with renewal terms that could extend the tenant’s occupancy for more than five years in the aggregate, must be recorded in order to be binding on bona fide purchasers. See Great Atl. & Pac. Tea Co. v. Cofer, 129 Va. 640, 106 S.E. 695 (1921).

The decision of whether or not to record a lease or a memorandum of lease in the District of Columbia, Maryland or Virginia should be evaluated carefully in light of the information above. In the event the decision is made to record, it is advisable for a landlord to address with the tenant execution and delivery to landlord or escrow of a release of the recorded lease at the same time as the parties negotiate the recordation of the lease or the memorandum. For assistance in weighing the pros and cons of recording leases in these jurisdictions, contact the real estate attorneys at McGuireWoods LLP. For more information, visit our Greater Washington-Baltimore Region Transactional Real Estate practice.