By Sarah Everhart
The Agricultural Use Assessment is a reduced property tax assessment granted to either farmland or woodlands. The application of the assessment means that the land is appraised according to its current agricultural use and not according to its actual market value, which is often significantly higher. The assessment was enacted by Maryland in 1960 and was the first of its kind in the country. The purpose of the assessment is to give the landowner a property tax benefit to encourage keeping the land in either agriculture or forest as opposed to converting the land for development. Sellers and buyers of farmland need to understand the Agricultural Use Assessment so they can both enjoy the financial benefits and be aware of the potential associated tax liabilities and penalties.
For farmland to be eligible for the assessment, the land must be “actively used” for agricultural purposes. The State Department of Assessments and Taxation (SDAT) administers the assessment and determines whether farmland is actively used. To make the determination, SDAT considers the nature of the agricultural activity such as whether the land is tilled or is pasture, whether the agricultural activity is generally recognized by the agricultural community, whether the agricultural activity is the primary use of the land, and whether the agricultural use is continuing or temporary. If there is doubt as to whether land is being actively used for agriculture, a farmer can show SDAT that their agricultural activity results in an average annual gross income of $2,500 or more annually. The assessment generally cannot be used for small parcels of land. Specifically, farmland parcels must be larger than three acres unless certain criteria are met, and woodland parcels must be 5 acres to qualify. Residential uses such as farm houses and tenant houses are excluded from the assessment area and assessed at a residential property tax rate.
The assessment can be applied to woodlands if the woodland is associated with a farm or if it is a separate tract of woodland. In order for separate tracts of woodlands to qualify for the assessment, the landowner must obtain a forest management plan for the woodland approved by the Department of Natural Resources. To receive the assessment, the landowner must file a letter of intent with the local SDAT office. The letter of intent is a legal agreement in which the landowner agrees to keep the land in agricultural use for at least 5 years and to inform SDAT if there is a change in use.
What happens if a farmer has the assessment and decides to sell the land to a purchaser who will develop the land in whole or in part? In the event of a transfer, a sale of the land, or other action violating the letter of intent, the Agricultural Transfer Tax may become due. Another event that can trigger the Agricultural Transfer Tax is a rezoning at the request of the landowner, which results in the land having a more intensive zoning classification.
In cases other than a violation of a letter of intent, the Agricultural Transfer Tax applies when farmland is sold. The tax is imposed on the deed itself and must be paid before the deed can be recorded in the county land records office. Who pays the tax? In a sale of land, the seller has the obligation to inform the purchaser that the Agricultural Transfer Tax will be due as a part of the real estate contract, but it is ultimately the purchaser’s responsibility to pay the tax unless an alternative arrangement is negotiated. The Agricultural Transfer Tax, as illustrated below, may be substantial and can easily disrupt a sale if a purchaser is unaware of the extent of the obligation. The rate of the Agricultural Transfer Tax is 5% when the land involved in the transaction is 20 acres or more; the rate is 4% when the land is less than 20 acres in size; and the rate is 3% when the size of the tract is less than 20 acres and is a building lot with site improvements such as well and septic.
In addition to the tax, an additional 25% surcharge is added to the total amount due. The tax is calculated on the purchase price. For example, if a purchaser is buying 10 acres of unimproved waterfront farmland for $850,000, the Agricultural Transfer Tax rate would be 4% ($850,000 x 4%= $34,000) plus the 25% surcharge ($34,000 x 25%=$8,500) for a total Agricultural Transfer Tax of $42,500. If farm buildings or a homesite is present on farmland, the value of the buildings or homesite, as determined by SDAT, is subtracted from the total purchase paid to calculate the tax. In all real estate settlements involving the Agricultural Use Transfer Tax, the parties should inform their county SDAT office in advance of the settlement to avoid undue delay.
The only way for a purchaser to avoid the Agricultural Transfer Tax is to keep the land in agriculture or woods. The purchaser must sign a Declaration of Intent to that effect and file the same with SDAT. The Declaration of Intent requires the purchaser to promise to keep the land in agricultural or wooded use for 5 full taxable years after the transfer. This can be done for a part of the property purchased. For example, in the example above, if the purchaser is buying the 10 acres and will be keeping the land in agriculture except for a 2-acre home site, a Declaration of Intent can be filed for the remaining 8 acres.
What happens if after filing the Declaration of Intent, the purchaser decides to develop the property 3 years into the 5-year period? The full Agricultural Transfer Tax plus a penalty of 10% will be imposed. Using the example above, if the purchaser decides to subdivide and develop the 10 acres of unimproved waterfront farmland purchased for $850,000, the Agricultural Transfer Tax rate would be 4% ($850,000 x 4%= $34,000) plus the 25% surcharge ($34,000 x 25%=$8,500) plus a 10% penalty ($42,500 x 10%=4,250) for a total due of $46,750.
Certain transfers are exempt from transfer tax in Maryland (See, Maryland Code, Tax Property Article, Section 13-207). There are numerous exemptions but some of the most common are transfers to a family member or spouse, and transfers between closely related business entities. Independent legal counsel should be consulted regarding whether an exemption to the Agricultural Transfer Tax is applicable.
One important quirk of the Agricultural Transfer Tax is that the tax is imposed on land that receives or has received the agricultural use assessment. Once the agricultural use assessment is removed because, for example, land is converted from an agricultural use to a developed use, the land is assessed based on its fair market value, and real property taxes will be paid based on the higher assessment. For each year property taxes are paid on the fair market value assessment, the total amount of the tax due on a subsequent transfer is reduced by 25%. Thus, after four years, no tax would be due on a transfer and no Declaration of Intent would be required.