Decided: January 27, 2014
The Fourth Circuit combined two similar cases from the district courts of South Carolina and Maryland to consider whether the Federal National Mortgage Associate (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) are exempt from paying state and local taxes on the transfer of real property. Both district courts held that Fannie Mae and Freddie Mac were exempt from paying transfer taxes. The Fourth Circuit affirmed. In addition, the Fourth Circuit held that Congress acted within its power under the Commerce Clause in exempting Fannie Mae and Freddie Mac from property transfer taxes.
During the Great Depression, Congress created Fannie Mae to provide banks with more capital for mortgage lending with the intent that additional capital would increase credit stability and to provide additional access to residential mortgages throughout the country. In 1970, Congress established Freddie Mac as a competitor to Fannie Mae, with similar purposes. Fannie Mae and Freddie Mac met these goals by purchasing mortgages originated by third-party lenders, pooling the mortgages into securities, and then selling those mortgage-backed securities to fund further purchases. Ideally, these activities promote access to mortgage credit and stabilize the residential lending market. To help accomplish their goals, Congress exempted Fannie Mae and Freddie Mac generally from all state and local taxes “except that any real property [of Fannie Mae or Freddie Mac] shall be subject to State, territorial, county, municipal, or local taxation to the same extent as other real property is taxed.” Like many other states, South Carolina and Maryland impose taxes on the ownership and the transfer of real property. The Counties of South Carolina and Maryland charged with collecting property transfer taxes (“Counties”) claim that the exemption did not apply to the transfer taxes because of Congress’ real property exception to the tax exclusion. On the other hand, Fannie Mae and Freddie Mac claim that the real property exception is sufficiently narrow to only cover the payment of property ownership taxes and thus, does not extend to similarly require the payment of property transfer taxes. The district courts of South Carolina and Maryland agreed with Fannie Mae and Freddie Mac, upholding the exemption. The Counties appealed.
On appeal, the Fourth Circuit first affirmed the district court’s determination that the tax exemption applied to property transfer taxes. Courts have consistently distinguished general property taxes from taxes levied on the transfer of property. The Fourth Circuit noted the extensive Supreme Court precedent providing that recording taxes are distinct from property taxes, explaining that “a privilege tax is not converted into a property tax because it is measured by the value of the property.”
Secondly, the court affirmed the constitutionality of the tax exemption. The court began by noting that Congress only needed a “rational basis” to grant the exemption from state taxation. The Counties argued that Congress did not have a rational basis to grant such an exemption because the transfer tax was purely a local, intrastate activity beyond Congress’ control. The Fourth Circuit disagreed, emphasizing the substantial economic effect that Fannie Mae and Freddie Mac had on the nationwide mortgage market. The 2008 mortgage collapse provided ample evidence of the extensive impact that local mortgages have on the entire nation’s economy.
Convinced that mortgage lending has a substantial effect on the nation’s economy, the Fourth Circuit then considered whether Congress’ tax exemption was necessary and proper to Congress’ legitimate exercise of its power under the Commerce Clause. The Court held that “Congress could rationally have believed that state taxation would substantially interfere with or obstruct the legitimate purposes of Fannie Mae and Freddie Mac of regulating and stabilizing the secondary mortgage market.” First, imposing excessive taxes on Fannie Mae and Freddie Mac could undermine their ability to purchase mortgages by reducing their access to capital. Second, the inconsistencies in state property transfer taxes would impose varied transactions costs between states that may undermine the ability to provide the same mortgage liquidity to all parts of the country. Third, without such an exemption, the large volume of the mortgage portfolios held by Fannie Mae and Freddie Mac would pose an attractive target for large taxes by states and localities. Thus, the Fourth Circuit held that the tax exemption was a necessary and proper exercise of Congress’ Commerce Clause power.
– Wesley B. Lambert