Whether D.C. failed to collect taxes on large property transactions under review
By Mike DeBonis,
Authorities are reviewing whether the D.C. government, over the course of a decade, failed to collect taxes on certain large property transactions.
When some loans are refinanced, the city is supposed to collect a tax, which can total hundreds of thousands of dollars for some big downtown properties. At the center of the inquiry is whether the District missed out on millions of dollars in recordation taxes.
Representatives of Chief Financial Officer Natwar M. Gandhi and D.C. Attorney General Irvin Nathan confirmed that their offices are reviewing the matter and will publicly issue their findings in the coming weeks.
The legal review comes months after two Washington lawyers approached Gandhi’s office claiming knowledge of a method used by large property owners, their lenders and their attorneys to evade the payment of those taxes. During several meetings, the would-be whistleblowers proposed, for a fee, to search on the city’s behalf for any owed taxes and penalties.
City officials reacted warily, and the lawyers now say they are no longer seeking profit.
But in a letter sent to Gandhi and Nathan last Wednesday, Jeffrey A. Mitchell did not back down from his assertion of a widespread problem, saying it was “pervasive . . . potentially resulting in hundreds of millions of dollars of unpaid taxes.”
Mitchell, a partner with the Oldaker Law Group, joined with James V. Stanton, a lawyer and former Ohio congressman, in pursuing the collections. Douglas J. Patton, a former deputy mayor and a colleague of Mitchell’s, arranged and participated in meetings with city officials, including Mayor Vincent C. Gray (D).
David Umansky, a spokesman for Gandhi, who oversees the city’s tax collections, said Tuesday that his office is skeptical that the issue is as widespread as Mitchell and his associates allege. “At no time did they provide us with proof that millions and millions of dollars have been lost in illegal transactions,” Umansky said.
Representatives from Gandhi’s office, including General Counsel David C. Tseng and Deputy Chief Financial Officer Stephen M. Cordi, who heads the tax office, met with Mitchell and his associates on three occasions, most recently March 29.
Without an audit, it is difficult to estimate how much revenue the city could have failed to collect if Mitchell’s reading proves correct. For downtown office buildings — which are regularly bought and sold for tens of millions, if not hundreds of millions, of dollars — recordation taxes often total hundreds of thousands of dollars per transaction. And the period in question includes the most active and prosperous years the city’s real estate market has ever seen.
The issue dates to 2001, when the D.C. Council passed a broad package of tax reforms. One change ended a tax exemption for the refinancing of loans used to purchase commercial buildings. Previously, those transactions were exempt from the 1.1 percent recordation tax assessed on the loan’s principal. (The rate on most commercial properties was increased to 1.45 percent in 2006.)
By Mitchell’s analysis, the city should have assessed the tax on any portion of the loan that hadn’t already been taxed. In two memorandums issued in 2001, the Office of Tax and Revenue outlined this interpretation. An April 4 memo says that under a refinancing, “the entire amount of the new loan” would be subject to the tax. A second memo, sent Oct. 5, said the tax office “will fully assess the recordation tax on a refinance of commercial property if the tax was not paid on the existing debt.”
But documents researched on Mitchell’s behalf and verified in public records by The Washington Post show that in several cases, the city charged tax only on the new, additional debt taken out in a refinancing.
One building, on L Street NW, was purchased in 1986 with a $6 million loan, a transaction that was and remains exempt from recordation tax. In 1999, the owners took out a new loan, for $7 million. No recordation tax was collected. In September 2007, the owners of the building refinanced, taking $12 million this time, but the city assessed tax only on the $5 million difference. Under the 2001 law change, Mitchell alleges, the full $12 million should have been taxed, which would have net an additional $101,500 for the city.
In other cases, Mitchell alleges that property owners took measures to hide taxable transactions — in particular, by refinancing properties without filing the documents that would trigger the tax. Instead, the property owners have filed “amended” loan documents, which indicate a change in the documents but not the refinancing.
Documents provided by Mitchell appear to illustrate one such transaction, for a building on K Street NW, where the city levied tax only on $11.5 million of a $40 million note, potentially costing the city $313,000. In his letter, Mitchell refers to “several deals [that have] come across my desk in the past few years” that employed similar methods. Mitchell said he counseled against approving the deals, but colleagues went forward with the transactions, which involved potential unpaid taxes totaling about $5 million.
“I am a single attorney in a city with hundreds (perhaps thousands) of real estate lawyers,” Mitchell wrote in his letter. “Unless, against all statistical probability, I am the only lawyer who has seen the Evasion Method used . . . the amount of unpaid taxes could be significant enough to substantially reduce the budget deficit currently facing the District of Columbia.”
D.C. Council member Jack Evans (D-Ward 2), who oversees the tax office, said he was concerned by Mitchell’s allegations. “If they were supposed to be collecting this tax, and they didn’t do that, it’s really a problem,” he said.
Mitchell said an audit reviewing 10 years of property records would cost between $1.5 million and $2.5 million.
But if city lawyers endorse Mitchell’s reading of the law, they are likely to encounter serious resistance from the District’s real estate industry — particularly if they pursue an audit and attempt to recoup back taxes and penalties.
Roy L. Kaufmann, an attorney for the D.C. Land Title Association, said that Mitchell’s allegations contain “some serious, erroneous presumptions” and that he was not aware that there was ever any intent to levy taxes on the original principal of a purchase loan.
“This matter has been reviewed time and time again by a very conscientious [Office of Tax and Revenue], and it appears to me that the correct interpretation has been consistently applied,” Kaufmann said.
A D.C. Council committee report on the 2001 legislation indicates there was little, if any, discussion of ending the recordation tax exemption. In 2007, Robert McKeon, the top attorney for the city tax office, wrote to Kaufmann, saying that “modifications” would be taxed on the sum “over and above” the previous amount financed, regardless of whether it had been previously taxed or not. Umansky said that reflects the city’s “current policy.”
Mitchell said that McKeon’s reference to “modifications” would not include bona fide refinancings. “One has to do with changing the documents; refinancing has to do with changing the money,” he said.
Should lawyers determine that Mitchell’s interpretation is correct, it is unclear how much the city could expect to recover. Under D.C. law, the city has only three years after assessing a tax to modify that assessment. If property owners are found to be evading taxes, however, there is no time limitation.