Unpaid seller’s privilege: a tax contingency that must be assessed before purchasing real estate
Written by: Hidalma De Castro and Jacqueline Fernández
In real estate transactions, it is common for companies and individuals to choose to buy or sell properties with deferred payments or in installments to optimize their financial liquidity and facilitate the closing of transactions.
These types of transactions are typically documented through a definitive purchase agreement, in which the parties sometimes agree that the sale price will be paid through installment plans, giving rise to the unpaid seller’s privilege, a legal concept that allows for the sale of real estate without the sale price having been paid in full, thereby protecting the seller and guaranteeing priority of collection in the event of the buyer’s default.
In order to provide useful information to those involved in real estate transactions with deferred payments, this article discusses the legal scope of the unpaid seller’s privilege and the tax treatment applied by the General Directorate of Internal Revenue (DGII) to the tax arising from contracts in which this provision applies.
What is the unpaid seller’s privilege?
The Dominican Civil Code provides that privileges are rights granted by law to a creditor, giving them priority in collecting their claims against the debtor’s assets.
Among the privileges on real property is the unpaid seller’s privilege, which arises when a person sells a property and the buyer fails to pay the full purchase price at the time the final sales contract is signed.
In this case, upon transfer of the property in question, the law grants the seller the right to claim payment of the outstanding balance of the purchase price with priority over any other creditors the buyer may have, including mortgages or other liens that may encumber the property.
This privilege applies automatically by law, unless the seller expressly waives it in writing in the sales contract. Therefore, if the sales contract stipulates that there is an outstanding amount to complete the sale price and there is no express waiver clause by the seller, when requesting the transfer of the property at the Registry of Deeds, said privilege is automatically registered so that it is effective against third parties.
In the event of default by the buyer, the seller’s unpaid privilege allows the seller to pursue the property through the corresponding enforcement proceedings and exercise their right to priority collection, which provides significant protection in deferred-payment sales.
Tax treatment: law vs. practice
Law No. 173-07 on Tax Collection Efficiency establishes, among other things, two main taxes applicable to real estate transactions in the Dominican Republic:
-A unified 2% ad valorem tax, applicable to certain real estate transactions, such as the creation of mortgages.
-A flat tax of 3% on the transfer of real property.
However, this law does not expressly provide for any tax applicable to the unpaid seller’s privilege.
Nevertheless, in practice, based on administrative guidelines, the DGII is requiring the payment of an additional 2% on the outstanding balance of the sale price when a company or individual enters into a real estate transaction with deferred payment.
As a result, the buyer is typically required to pay:
– The 3% real estate transfer tax, and
-An additional 2% on the outstanding balance, as a “Tax on the Unpaid Seller’s Privilege.”
A legal concept, not a financial transaction
From a legal standpoint, the unpaid seller’s privilege does not constitute a financial transaction or a mortgage-backed contract, but rather a legal right recognized in the Civil Code, which arises as a direct consequence of the sales contract when the purchase price is not paid in full.
Therefore, it is debatable whether this concept should be subject to the same tax treatment as other transactions expressly taxed under Law No. 173-07.
To the extent that it is considered part of a real estate transaction, it would be reasonable to apply exclusively the three percent (3%) tax corresponding to the transfer of the property, since it is an ancillary element and not an independent legal act.
The importance of proper legal advice
The unpaid seller’s privilege is a tool designed to provide legal certainty to sellers in real estate sales involving deferred payments.
However, the current tax treatment of this privilege can represent a significant additional cost for buyers, especially in transactions involving long-term deferred payments.
Given this scenario, it is essential that sellers and buyers of real estate with deferred payments carefully evaluate the legal and tax structure of the transaction, as well as the associated costs, before finalizing the deal.
Timely legal advice can make the difference between a secure transaction and an unexpected tax contingency.
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