Friday May 3, 2019
Introduction to the Improvement Tax
The State of Delaware and Sussex County assess a tax on contracts for the improvement of land that has been held less than a year. This tax catches many people by surprise. It is colloquially known as the “Improvement Tax”, but the tax is actually an extension of the Realty Transfer Tax which is generally assessed when real property is bought or sold and well understood by most people.
The Improvement Tax was originally enacted to close a perceived loophole in the Realty Transfer Tax system. The theory is that someone who buys a lot and builds a new home soon thereafter should not pay less transfer tax than someone who simply purchases a completed home. Developers were gaming the system by selling the lot to the buyer and simultaneously entering into a construction contract for the home, reducing the transfer tax on what is effectively the same transaction as the sale of a completed home. Closing the loophole makes theoretical sense, except that a buyer of a completed home typically splits the transfer tax evenly with the seller, whereas the buyer who hires a builder to construct a new home on their own lot pays the entire Improvement Tax.
How it Works
While the Transfer Tax structure is a creature of the State, the trigger for assessing the tax is usually the delivery of a “document” to the County. The Sussex County Code defines a “document” to include a home construction contract. The County becomes aware of the existence of a contract when the builder submits the plans for a building permit. Long story short – you can’t get a building permit (or a Certificate of Occupancy) from the County until you pay the tax.
The Tax Rate
The State of Delaware assesses the tax at the rate of 2% on the amount of the construction contract after deducting a $10,000 exclusion. Sussex County requires the payment of 1.5% on the total construction contract amount, plus proof that the State portion has been paid, before they will issue the building permit. Hence, the combined effective rate is a little less than 3.5% of construction cost and is paid entirely by the homeowner.
Avoiding the Tax
The only real way to avoid the tax is to wait for the one-year period to expire. However, there are risks to this strategy. The biggest risk is that the construction cost of the house will go up while you’re waiting, mitigating or perhaps surpassing any savings from avoiding the tax. No builder can honor a bid for that long because commodity prices can be very volatile. Another risk specific to the resort market is potentially losing a complete summer of potential usage (or potential rental income). We sometimes recommend that lot owners proceed immediately with construction if the timing allows them to rent enough summer weeks to recoup the tax.
At Turnstone Custom Homes, one of the first questions we ask a new prospect is “how long you have owned your lot?”. If the lot has been owned for less than a year, we will discuss your options and help you make an informed decision whether to delay your building permit application to avoid the tax.
Relevant Code Sections Below
Relevant Code Sections
The Sussex County Code includes this provision:
Every person who makes, executes, delivers, accepts or presents for recording any document, except as defined or described in § 103-18D herein, or in whose behalf any document is made, executed, delivered, accepted or presented for recording, shall be subject to pay for and in respect to the transaction, or any part thereof, a realty transfer tax at the rate of 1 1/2% of the value of the property represented by such document, which tax shall be payable at the time of making execution, delivery, acceptance or presenting of such document for recording. In the absence of any agreement to the contrary, the burden for paying the tax shall be apportioned equally between the grantor and the grantee.
[Amended 7-1-1998 by Ord. No. 1247]
Documents; issuance of building permits and certificates of occupancy; building.
[Added 12-2-2008 by Ord. No. 2007]
Notwithstanding the foregoing provisions of this section, there shall be included in the definition of "document" for the purposes of this article any contract or other agreement or undertaking for the construction of all or a part of a building, all or a portion of which contract, agreement or undertaking (or any amendment to the foregoing) is entered into, where labor or materials are supplied, either prior to the date of the transfer of the land on which the building is to be constructed or within one year from the date of the transfer of the land to the grantee.
The County shall not issue a building permit for any such building unless and until the person or persons (including corporations, other associations or entities) requesting such permit shall demonstrate in whatever form may be specified and required by the County Director of Finance, including at the Director's discretion, a form of affidavit certifying that:
No transfer as described in this section has occurred within the preceding year; or
No portion of the contract for construction for which the permit is being requested was entered into and no materials or labor with respect to the building have been provided within one year of the date on which the land was transferred; or
The required amount of the County realty transfer tax on the document, as defined in this article, has been paid.
The relevant Delaware statute is found here:
Delaware Code Title 30
CHAPTER 54. REALTY TRANSFER TAX
Subchapter I. Realty Transfer Tax
(9)a. Notwithstanding paragraph (1) of this section, there shall be included in the definition of "document" for purposes of this chapter any contract or other agreement or undertaking for the construction of all or a part of any building all or a portion of which contract, agreement or undertaking (or any amendment to the foregoing) is entered into, or labor or materials are supplied, either prior to the date of the transfer of the land on which the building is to be constructed or within 1 year from the date of the transfer to the grantee.
b. No jurisdiction in this State shall issue a building permit for any such building unless and until the person or persons (including corporations or other associations) requesting such permit shall demonstrate in whatever form may be specified by the Director of Revenue, including at the Director's discretion, a form of affidavit, that:
1. No transfer as described in this section has occurred within the preceding year;
2. No portion of the contract for construction for which the permit is being requested was entered into and no materials or labor with respect to the building have been provided within 1 year of the date on which the property was transferred; or
3. There has been paid a realty transfer tax on the document as defined in this paragraph.
c. In addition, no jurisdiction in this State shall issue a certificate of occupancy relative to any building on which a tax is provided by this subsection unless and until the owner recertifies the actual cost of the building and pays any additional tax due as a result of such recertification.
DCE - Spoke to Sussex County Recorder of Deeds office 4/17/2019
They confirmed they take 1.5%. But only after presenting evidence that the State transfer tax is paid. She did not know if State is 2% or 2.5%.
Called DE Division of Revenue on Georgetown and spoke to Kim. She confirmed that the State takes 2%, not 2.5% as appears in some Google search results. Also, there is a $10,000 deduction before computing the State share.
So, the combined rate is 3.5% for improvements.