Deed Warranties and Why They Should Matter To You

You’re negotiating to buy a piece of real estate and your attorney tells you that the seller is proposing to give you a “Special Warranty Deed” in exchange for all of the money you will pay.

Special Warranty Deed – that sounds nice, doesn’t it?  But what does that term really mean?

In order to appreciate what a Special Warranty Deed will mean to you as a buyer, it will help to know a little about the different types of deeds commonly used in North Carolina.  The three most common types of deeds are:

  • General Warranty Deeds;

  • Limited Warranty Deeds; and,

  • Non-Warranty Deeds.

General Warranty Deeds

In a General Warranty Deed, the seller usually gives four warranties regarding the land to the buyer.  The seller warrants to the buyer that:

  • The seller has the right to convey the real estate.

  • The seller will defend the title to the real estate against the claims of all persons.

  • The seller is “seized of the fee” in the real estate. “Seized of the fee” basically means that the seller warrants that the seller owns all of the rights in the real estate except as specifically stated in the deed.

  • There are no encumbrances against the real estate that are not listed in the deed. An encumbrance could be a simple (even beneficial) easement that allows the power company to install a power line across the property or a multi-million dollar judgment lien against the property.  An encumbrance could be just about anything you might imagine that impacts (usually negatively) the use or value of the property, including restrictive (sometimes called “protective”) covenants that control how the real estate may be used.

Limited Warranty Deeds

However, in a Limited Warranty Deed, the seller usually gives only two warranties.  The seller usually warrants to the buyer that:

  • The seller personally has not done anything to the title that the seller received. This is a much more limited warranty than the broad warranty found in a General Warranty Deed.  As explained above, in a General Warranty Deed the seller warrants that the seller not only owns the property, but also has all of the rights in the property except as specifically stated in the deed.

  • The seller will defend the title to the property against claims based on the prior actions of the seller, but no one else. This also is a much more restrictive warranty than that found in the General Warranty Deed.  As noted above, in a General Warranty Deed the seller warrants that the seller will defend the title against the claims from all parties except as specifically stated in the deed.

Limited Warranty Deeds go by various names, including “Special Warranty Deeds.”  Sometimes Limited Warranty Deeds are named after the grantor, such as a “Trustee’s Deed” or an “Executor’s Deed,” but they all share the same characteristic in that they warrant only against the grantor’s own acts.

Non-Warranty Deeds

As one might imagine, the seller gives no warranties in a Non-Warranty Deed.  A Non-Warranty Deed is sometimes called a “Quitclaim Deed.”  Although lawyers quibble over whether there is a difference between a Non-Warranty Deed (which actually purports to convey something) and a Quitclaim Deed (which only releases any claims the grantor has in the land), they all share the same characteristic that they contain no warranty, even against the grantor’s own acts.  In a Non‑Warranty or Quitclaim Deed, the seller merely is giving the buyer whatever rights, if any, that the seller has in the property and the seller makes no warranties of any nature about the seller’s rights in the property.

But What About The Special Warranty Deed?

A Special Warranty Deed is just a Limited Warranty Deed with an appealing name.

But what does it matter if you get a Limited or Special Warranty Deed when you buy a piece of property as opposed to another type of deed?  As long as no title problems come up, it probably will not make any difference whether the seller gives you a General Warranty Deed, a Limited Warranty Deed, or a Non-Warranty Deed.  However, if a title problem should arise, the deed warranties may make a big difference to you.

Let’s take a quick look at what would occur under the different deed warranties when a simple title problem arises.  Let’s assume that you purchased your office building in 2021 from Sam Seller.  Being familiar with the area and Sam Seller, you know that Sam purchased the building from the developer in 2020.  You also know that the developer went out of business at the end of 2020.  When you purchased the property in 2021, everything went smoothly.  Everything was still going well until this past weekend when you received a notice from the county tax office indicating that the 2018 property tax bill on your office building had not been paid and the county has a lien on your property for several thousands of dollars.  Yikes!  As you scramble to locate your purchase file, let’s consider how the different deed warranties could affect your attitude once you actually find your file.

If you had received a General Warranty Deed from Sam Seller, then Sam would have warranted to you that there were no encumbrances against the property that were not listed in the deed.  So unless the deed specifically indicated that the property was conveyed to you “subject to” the 2018 unpaid taxes, you should be able to sleep restfully knowing that Sam owes you the money for the unpaid taxes.

If you had received a Limited or Special Warranty Deed though, your sleep will not be as restful.  In a Limited Warranty Deed, Sam would have warranted simply that he had not done anything to encumber or otherwise harm the title to the property while he owned the property.  Unfortunately, Sam Seller did not own the property in 2018 when the 2018 taxes became a lien on the property or in January 2019 when they became past due.  As you will recall, Sam bought the property in 2020.  Consequently, the warranties found in a Limited Warranty Deed from Sam would not cover the unpaid 2018 taxes, and Sam would not be liable to you for the unpaid taxes.

Of course, if you had received a Non-Warranty or Quitclaim Deed from Sam Seller, then Sam also would not be liable to you for the unpaid taxes.  As mentioned above, under a Non‑Warranty or Quitclaim Deed, Sam would not have warranted anything to you about the property.  You simply would have received whatever rights (if any) that Sam had in the property at that time, and Sam’s rights were subject to the lien of the 2018 taxes.

What To Do If Offered A Special Warranty Deed

So, how do you protect yourself from issues that may arise when you will receive a Special Warranty Deed?  Here are three things to do the next time you decide to buy property:

  • Regardless of the type of deed to be given at closing, get your attorney involved in the transaction before you sign a contract. Even if the contract provides for a General Warranty Deed, other language in the contract could reduce the general warranties.  For example, contract language that indicates the property will be conveyed by a General Warranty Deed “subject to all matters of record” sounds reasonable, but the “subject to” language essentially negates the general warranties because most matters encumbering title to the property will be “of record.”

  • Have your attorney conduct a title examination on the property to discover any encumbrances or title problems before you purchase the property. Even if there are no title problems, this is where your attorney will discover those “little” things that could become big problems if you did not know about them prior to purchasing the property.  For example, this is where your attorney would discover that the large open area behind the office building is subject to an easement in favor of the owner of the adjoining property that would prevent you from expanding the building into that area.

  • Have your attorney obtain title insurance for you. Title insurance will give you additional protection from unknown title risks that could raise their ugly heads in the future.  Although title insurance does not guarantee that you will not have a title problem, it does provide insurance to help pay to correct the problem or to compensate you if the problem cannot be corrected.

Conclusion

Understanding deed warranties will help you to better protect yourself from title problems and possible litigation in the future.  Special and Limited Warranty Deeds really aren’t that special and might not grant you the protections you think.  Even still, other deeds may not contain any protection for a buyer at all.

© 2022 Ward and Smith, P.A.. All Rights Reserved.
For more Real Estate Legal News, click here to visit the National Law Review.

CDC Issues Temporary Halt in Residential Evictions Nationwide to Prevent the Spread of COVID-19

On September 1, 2020, the Centers for Disease Control and Prevention (“CDC”) issued an Order under the Public Health Service Act Section 361 to temporarily halt residential evictions nationwide through December 31, 2020, to prevent the further spread of COVID-19.

Under the Order, a landlord, residential property owner, or other person with a legal right to pursue eviction action, cannot evict any tenant, lessee, or resident of a residential property from the property. The Order applies to all State, local, territorial, or tribal area in which there is no moratorium on residential evictions that provides the same or greater level of protection than this Order.

The Order does not relieve any tenant of its obligation to pay rent, make a housing payment, or comply with any other obligation under a tenancy, lease, or similar contract. The Order also does not preclude a landlord’s ability to charge or collect fees, penalties, or interest as a result of the failure to pay rent or other housing payment in a timely manner. Tenants are still required to pay rent and follow all the other terms of their lease, and may still be evicted for reasons other than not making a housing payment.

To invoke the CDC’s Order, tenants must sign and provide an executed copy of a Declaration form (or a similar declaration under penalty of perjury) attesting to their current circumstances and inability to pay, to the party attempting to enforce an eviction. A sample Declaration form is attached to the CDC Order and requires that the tenant seeking relief from eviction attest that the tenant: (1) expects to earn no more than $99,000 in annual income for Calendar Year 2020 (or no more than $198,000 if filing a joint tax return), (2) is unable to pay the full rent due to substantial loss of household income or extraordinary out-of-pocket medical expenses, and (3) will likely have no other option if evicted other than homelessness or living with more people in close proximity.

The Order, which does not include any provisions for rental and unemployment assistance, is being met with mixed responses. While many housing advocates welcome the action by the CDC, rental property owners are expressing concerns that the Order would negatively affect the stability of the rental housing sector. “An eviction moratorium will ultimately harm the very people it aims to help by making it impossible for housing providers, particularly small owners, to meet their financial obligations and continue to provide shelter to their residents,” said Doug Bibby, president of the National Multifamily Housing Council.

A full copy of the CDC Order can be found here.


© 2020 SHERIN AND LODGEN LLP

This article was authored by Trang Pham of  Sherin and Lodgen. 

For more articles on real estate, visit the National Law Review Real Estate, Transportation, Utilities and Construction Law News section.

California’s New Statewide Rent Control – What You Need to Know

Summary:

As expected, California’s legislature passed AB 1482 this month, which imposes statewide rent control, restricting the ability of landlords to terminate certain tenancies without just cause, and further restricting the ability of landlords to increase rent on an annual basis. For those properties already subject to rent control, the new law is unlikely to change much if anything, but owners of other residential rental properties should be aware of the new restrictions.

Below is a summary of the key points of the new law.

When does it apply? 

AB 1482 applies to tenants that have occupied a dwelling unit for more than 12 consecutive months. If additional adult tenants are added during the lease term, it applies once the new tenant has occupied for 12 months, or one of the existing tenants has occupied the unit for 24 or more consecutive months.

What properties are exempt? 

AB 1482 applies to all residential properties in California, excluding the following:

  • Housing that has been issued a certificate of occupancy within the previous 15 years.
  • Transient and tourist hotel occupancy.
  • Housing accommodations in a nonprofit hospital, religious facility, extended care facility, licensed residential care facility for the elderly or an adult residential facility.
  • Dormitories owned and operated by colleges or schools.
  • Housing accommodations in which the tenant shares bathroom or kitchen facilities with the owner who maintains their principal residence at the residential real property.
  • Single-family owner-occupied residences, as long as the owner does not lease more than 2 units (including ADUs).
  • A duplex in which the owner occupied one of the units as the owner’s principal place of residence at the beginning of the tenancy, so long as the owner continues in occupancy.
  • Residential real property that is alienable separate from the title to any other dwelling unit, provided the owner is not a REIT, corporation or limited liability company in which at least one member is a corporation, and further subject to certain tenant notice requirements.

What are the limitations on increasing rent?

The bill restricts the owner of residential real property from increasing rent during any 12-month period by more than the lesser of (i) 5% plus a cost of living adjustment based on the California CPI, or (ii) 10%. The percentage increase in any 12-month period is based on the lowest applicable rate during the preceding 12-month period, but the value of any rent discounts, incentives or other concessions made by the landlord are not taken into account when determining the lowest rate in effect during such period.

When can a landlord terminate a lease? 

A landlord can terminate the lease for at-fault just cause for (i) defaults in the payment of rent, (ii) a material breach of the lease, (iii) nuisance uses, (iv) illegal or criminal activities, (v) committing waste, (vi) refusal by the tenant to sign a lease extension, (vii) refusal by the tenant to allow owner entry as required by law, (viii) assignment or subletting in violation of the lease, (ix) failure to vacate after signing a vacation agreement, or (x) failure to vacate upon termination of employment.

A landlord can also terminate for no-fault just cause if (i) the owner or certain family members intend to occupy the property (for leases entered into after July 1, 2020 other requirements must be satisfied), (ii) the property is withdrawn from the rental market, (iii) the owner is required by law to vacate the property (and if the tenant was the cause, the tenant will not be entitled to relocation assistance), or (iv) the owner intends to demolish or substantially remodel the property.

For any no-fault just cause termination, the landlord must provide the tenant with relocation assistance by either paying the tenant an amount equal to one month’s rent or waiving in writing the final month’s rent before the same is due. A landlord’s failure to strictly comply with the provisions relating to a no fault just cause termination renders the termination void.


© Polsinelli PC, Polsinelli LLP in California

For more on rental laws, see the National Law Review Real Estate law page.

Pontiff’s Visit to Philadelphia (Part III) – Top Five (5) Last Minute Tips for Landlords/Owners

It’s just a few days away! The papal visit is expected to bring more than 2 million visitors to the Philadelphia area. Our last two articles (here and here) dealt with the positive economic impacts for the region and managing the masses during this event. Here are five (5) tips that should be at the top of the list for landlords and owners of commercial, retail and multi-family properties.philadelphia skyline

Review your Leases. With an event of this magnitude, it is a good time to take a last minute look at your leases to ensure all items are appropriately addressed. For instance, does your lease have certain notice requirements for limiting access to parking areas designated for tenants and their customers? If you plan on sectioning off certain parking areas, did you send notice out in time? Sometimes leases will have a provision that allows you to circumvent certain notice requirements, if actions are done for health and safety reasons.

Consider Beefing Up Your Property Management for the Next Few Days. If you are an owner or landlord for a smaller shopping center or property, you may not have an onsite property manager. Even if you have an on-site manager, they may be assigned to multiple addresses, and this influx of visitors will leave him or her feeling stretched too thin. With more than 2 million people expected to visit the region this weekend, you may want to contact a reputable property management company to ascertain an on-site person or add to your existing property management team. They say “Cleanliness is Next to Godliness.” Ensuring that trash, landscaping and other property management issues are addressed properly and timely can make your property sparkle to the masses.

Consider Alternate Routes to Access Your Property. Considering this enormous occasion, security and police presence will be high to protect the Pope, as well as ensure everyone has an enjoyable experience. If you are a property owner or landlord, you may want to advise your tenants of possible alternate routes to ensure they can cater to the crowds. Further, you probably want your property management team to know about these alternate routes as well to guarantee they can access your property in the event traffic is diverted.

Check Your Insurance Coverage. It’s times like these that remind you to check both your insurance policy coverage, as well as your tenants’. Have you requested evidence of your tenants’ coverage? As Philadelphia’s own Benjamin Franklin said, “An ounce of prevention is worth a pound of cure.” You may want to contact your insurance broker to obtain increased or special coverage.

Always Remember, When in Doubt, Contact Counsel. There are a multitude of issues that can arise when so many people attend a once in a lifetime event like this. The Pope’s visit is a true blessing, highlighting our region. It will be something that we will never forget. Now, more than ever, it is important to discuss your commercial, retail, and other property needs with experienced legal counsel to achieve your goals and resolve any issues.

Restaurants, caterers and vendors will feed the hungry. Retailers will cloth the attendees. And the Pope will provide a spiritual lift to everyone. Make sure that you and your property are well prepared for this fantastic event.

COPYRIGHT © 2015, STARK & STARK

Quicken Loans Takes on the DOJ & HUD

Quicken Loans, the nation’s largest Federal Housing Administration (FHA)-backed mortgage lender,filed suit on Friday, April 17 in the United States District Court in Detroit against the United States Department of Justice (DOJ) and the Department of Housing and Urban Development (HUD). In the suit, Quicken alleged that it is a target of a probe in “which the DOJ is ‘investigating’ and pressuring large, high-profile lenders into publicly ‘admitting’ wrongdoing.” Quicken says the government threatened to file a lawsuit against it unless the company paid damages based on a sampling of its loans backed by the FHA. The government wanted payment of damages to be coupled with an admission by Quicken that its lending practices were “significantly flawed,” and that it had committed wrongdoing.

The company says that the public statements the government wanted it to make were blatantly false. Quicken also asserts that, before filing its lawsuit, it had already provided the DOJ with more than 85,000 documents, including 55,000 emails. In addition, the DOJ, without filing any lawsuit against Quicken, has conducted hundreds of hours of depositions from numerous Quicken team members. Three years later, the DOJ inquiry has (according to Quicken) resulted in the threat of a federal lawsuit based on “faulty analysis of a miniscule number of cherry-picked mortgages from the nearly 250,000 FHA loans the company has closed since 2007.”

According to FHA statistics, Quicken has originated the government agency’s best performing loan portfolio. The FHA’s publicly available data appears to establish that Quicken has the lowest “compare ratio” — the default rate of a single lender compared to FHA’s total mortgage portfolio — in recent years.

Not surprisingly, the DOJ responded by filing its own lawsuit against Quicken on Thursday, April 23, contending that it made hundreds of improper loans through the FHA lending program, allegedly costing the agency millions of dollars. The Justice Department contends that from September 2007 through December 2011, Quicken knowingly submitted claims — or caused the submission of claims — on hundreds of bad loans, and encouraged an underwriting process in which employees disregarded the program rules and falsely certified that loans met the requirements.

The F.H.A. — which allows borrowers to make down payments of as little as 3.5 percent — has already paid millions of dollars in insurance claims on the improperly underwritten loans, according to the complaint; it said many additional loans had become at least 60 days delinquent and could result in further claims.

The Justice Department, which has filed the suit under the False Claims Act, has already reached settlements with several lenders over their F.H.A. lending practices, including JPMorgan Chase, SunTrust, U.S. Bank, and Bank of America.

It is likely that many other lenders, feeling unduly scrutinized by government agencies, are cheering Quicken’s decision to file suit and are more than a little sympathetic to Quicken’s position in the two suits currently pending (which may be consolidated at some point). The prospects for success for Quicken in the suit that it filed, however, are not necessarily bright. The government generally has immunity, and great discretion even when it does not have immunity, with respect to how it conducts its investigations or settles enforcement actions.

Nevertheless, the lawsuit may at the very least succeed in forcing government agencies to explain and justify their conduct, which might have an effect strongly desired by numerous lenders feeling “targeted” by those agencies. Specifically, the effect of reining in the excesses of governmental enforcement efforts, and making responsible government officials more inclined either to forgo certain investigations entirely, or streamline them in ways that place lesser burdens on companies that, after all, should be presumed not to be liable until the government actually proves otherwise.

© 2015 Bilzin Sumberg Baena Price & Axelrod LLP Authored by:  Philip R. Stein

Quicken Loans Takes on the DOJ & HUD

Quicken Loans, the nation’s largest Federal Housing Administration (FHA)-backed mortgage lender,filed suit on Friday, April 17 in the United States District Court in Detroit against the United States Department of Justice (DOJ) and the Department of Housing and Urban Development (HUD). In the suit, Quicken alleged that it is a target of a probe in “which the DOJ is ‘investigating’ and pressuring large, high-profile lenders into publicly ‘admitting’ wrongdoing.” Quicken says the government threatened to file a lawsuit against it unless the company paid damages based on a sampling of its loans backed by the FHA. The government wanted payment of damages to be coupled with an admission by Quicken that its lending practices were “significantly flawed,” and that it had committed wrongdoing.

The company says that the public statements the government wanted it to make were blatantly false. Quicken also asserts that, before filing its lawsuit, it had already provided the DOJ with more than 85,000 documents, including 55,000 emails. In addition, the DOJ, without filing any lawsuit against Quicken, has conducted hundreds of hours of depositions from numerous Quicken team members. Three years later, the DOJ inquiry has (according to Quicken) resulted in the threat of a federal lawsuit based on “faulty analysis of a miniscule number of cherry-picked mortgages from the nearly 250,000 FHA loans the company has closed since 2007.”

According to FHA statistics, Quicken has originated the government agency’s best performing loan portfolio. The FHA’s publicly available data appears to establish that Quicken has the lowest “compare ratio” — the default rate of a single lender compared to FHA’s total mortgage portfolio — in recent years.

Not surprisingly, the DOJ responded by filing its own lawsuit against Quicken on Thursday, April 23, contending that it made hundreds of improper loans through the FHA lending program, allegedly costing the agency millions of dollars. The Justice Department contends that from September 2007 through December 2011, Quicken knowingly submitted claims — or caused the submission of claims — on hundreds of bad loans, and encouraged an underwriting process in which employees disregarded the program rules and falsely certified that loans met the requirements.

The F.H.A. — which allows borrowers to make down payments of as little as 3.5 percent — has already paid millions of dollars in insurance claims on the improperly underwritten loans, according to the complaint; it said many additional loans had become at least 60 days delinquent and could result in further claims.

The Justice Department, which has filed the suit under the False Claims Act, has already reached settlements with several lenders over their F.H.A. lending practices, including JPMorgan Chase, SunTrust, U.S. Bank, and Bank of America.

It is likely that many other lenders, feeling unduly scrutinized by government agencies, are cheering Quicken’s decision to file suit and are more than a little sympathetic to Quicken’s position in the two suits currently pending (which may be consolidated at some point). The prospects for success for Quicken in the suit that it filed, however, are not necessarily bright. The government generally has immunity, and great discretion even when it does not have immunity, with respect to how it conducts its investigations or settles enforcement actions.

Nevertheless, the lawsuit may at the very least succeed in forcing government agencies to explain and justify their conduct, which might have an effect strongly desired by numerous lenders feeling “targeted” by those agencies. Specifically, the effect of reining in the excesses of governmental enforcement efforts, and making responsible government officials more inclined either to forgo certain investigations entirely, or streamline them in ways that place lesser burdens on companies that, after all, should be presumed not to be liable until the government actually proves otherwise.

© 2015 Bilzin Sumberg Baena Price & Axelrod LLP Authored by:  Philip R. Stein

Tax Issues in Divorce: Real Estate Itemization Credits

Stark and Stark Attorneys at Law

With the April 15th tax filing deadline quickly approaching, I am beginning to see an increase of the tax-related issues arise in my client’s cases.  The right of either of the parties to claim itemized deductions associated with the real estate taxes and mortgage interest paid on the marital residence is a frequent issue of contention.

It is important to first understand that if you were divorced in the early part of 2015 and filing under a “married, filed jointly” designation for the 2014 tax year, by default, you are sharing in the itemized deduction with your spouse due to the joint filing.  From a practicality standpoint, many divorced couples that file their last joint tax return together reach an agreement to equally split any tax refund or liability associated with their joint filing.

With a “married, filing separately” or “individual” tax filing designation, it is important to come to an agreement with your spouse or ex-spouse regarding the itemized deductions associated with the marital residence.  As the combined deduction between yourself and your spouse cannot exceed the actual interests or taxes paid in a tax year, getting ahead of the issue and reaching an agreement prior to either party’s tax filing is extremely important.

For successfully navigating this issue, I recommend that you consider the following three points:

How much did either party pay towards the mortgage interest and real estate taxes

With the overwhelming number of divorce matters settling by private agreement, it is important to take into consideration the financial obligations under the controlling agreement.  For example, if a party is behind on child support support or failed to make timely mortgage payments, they should not receive the tax benefit of claiming 50% of the mortgage interest or real estate tax deductions.

It is also common for the parties to pay a disproportionate amount towards the monthly mortgage/tax obligation due to either a greater income level or private agreement.  In these scenarios, I often find it useful for the parties to split the itemized deduction in direct proportion to the amount paid.

Balancing out the real estate tax deductions with other tax-related benefits.

Many parties often overlook the benefit of trading off real estate tax deductions with other tax-related benefits such as claiming the children as dependants, charity deductions or medical expenses.  If the goal is to equalize tax credits to both parties in a divorce litigation, applying other deductions or credits to one party may assist the parties in achieving their tax credit equalization plan.

Maximize your tax benefit by speaking with a qualified tax professional.

The goal of applying any itemized deduction is to reduce your adjusted gross income (AGI) by as much as possible.  As there may be scenarios in which it is beneficial from a tax standpoint for one spouse to claim the majority of the mortgage interest deduction, it is very important that you engage a qualified tax professional to maximize the tax benefit to both parties in the divorce process.  Similar to my previous point, if one spouse benefits from taking a disproportionate amount of the real estate itemizations, there are other available remedies to ensure that the other party receives similar tax benefits, such as, claiming children as dependants and/or a uneven distribution of the charity donations.etc.

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New Jersey Law Blog

Real Estate Joint Venture Tips

recent New York Times article described the increased presence of New York developers in the South Florida condominium market. The fact is that Miami real estate market has always been a seductive one for out of state developers, and the upside in the development opportunities in the South Florida real estate market simply continues to proliferate. Best of all, more interest in South Florida means more opportunities for local developers to partner with or enter into joint ventures with those venturing into this market.

As South Florida developers look to partner with real estate firms and investors to develop projects in South Florida, South Florida developers should pay particular attention to the removal provisions of the joint venture agreements or management agreements entered into with these firms and investors.  Typically, the removal of the developer should be limited to “cause,” such as  the developer committing some kind of “bad act” or materially breaching an agreement. Developers should be cautious about agreeing to any “performance standards” or similar removal triggers, which can allow a developer to be removed from the deal through no fault of its own. In connection with a breach of the agreement, developers should negotiate materiality standards and notice and cure rights. In addition, developers should negotiate the right to cure any default caused by any employee by firing that employee and having the opportunity to cure any damage caused by the employee.

Finally, the developer should make sure to have its removal conditioned on the developer being released from any guarantees related to the project or, if the release cannot be obtained, being indemnified from a credit-worthy affiliate of the joint venture partner for such guarantees. The developer should not continue to be on the hook for the project guarantees after the developer is no longer involved with the management of the project.

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2014 Year-End Illinois Estate Planning: It’s Time for a Careful Review

Much Shelist law firm logo

As 2014 comes to a close, now is the perfect time for careful planning to address the income, estate, gift and generation-skipping taxes that can directly affect you.  In addition to making sure your estate plan is up to date, making a few important decisions now can reduce your tax liability later.

Transfer Tax Exemption and GST Exemption

The exemption amount that individuals may transfer by gift and/or at death without being subject to federal transfer taxes increased in 2014 to $5,340,000; it will further increase to $5,430,000 in 2015.  The maximum federal estate tax rate remains 40%.  In contrast, Illinois imposes a state estate tax once a decedent’s estate exceeds $4,000,000 (which is not adjusted for inflation). The rates of Illinois estate tax range from 8% to 16% (with the Illinois estate tax paid allowable as a deduction for federal estate tax purposes). Both the federal and Illinois estate tax laws allow for a marital deduction for assets passing outright to a spouse or to qualifying trusts for the benefit of a surviving spouse.  Illinois allows this deduction to be claimed even if a marital deduction is not elected for federal purposes.

In order to impose a death tax at each successive generational level, a generation-skipping transfer (“GST”) tax – equal to the highest estate tax rate – is assessed on transfers to grandchildren or more remote descendants.  However, every taxpayer is also given a separate federal GST exemption equal to the federal transfer tax exemption (i.e., $5,340,000 in 2014 and $5,430,000 in 2015).

Estate planning documents should be reviewed to make certain that beneficial use of the federal and state transfer tax exemptions, federal and/or state marital deductions and federal GST exemption are being utilized.

Annual Exclusion Gifts

Making use of annual exclusion gifts remains one of the most powerful – and simplest – estate planning techniques. For 2014 (and 2015), individuals can make an unlimited number of gifts of up to $14,000 per recipient, per calendar year.  Over a period of time, these gifts can result in substantial transfer tax savings, by removing both the gift itself and any income and growth from the donor’s estate, without paying any gift tax or using any transfer tax exemption.  An individual cannot carry-over unused annual exclusions from one year to the next.  If such exclusions are not utilized by the end of the year, the balance of any annual exclusion gifts that could have been made for that year are lost.  These transfers may also save overall income taxes for a family, when income-producing property is transferred to family members in lower income tax brackets (who are not subject to the “kiddie tax”.)

Tuition and Medical Gifts

Individuals can make unlimited gifts on behalf of others by paying their tuition costs directly to the school or their medical expenses directly to the health care provider (including the payment of health insurance premiums).

Lifetime Utilization of New Transfer Tax Exemption

The ability to transfer $5,430,000 ($10,860,000 per married couple) – after annual exclusion and medical and tuition gifts, and without having to pay gift taxes – paves the way for many planning opportunities.  When combined with valuation discounts and leveraging strategies (e.g., family partnerships, sales to grantor trusts, grantor retained annuity trusts,  etc.), tremendous amounts of wealth may pass for the benefit of many generations free of federal and Illinois transfer taxes. Lifetime gifts utilizing the exemption amounts will almost always result in overall transfer tax savings (unless the assets which have been transferred decline in value). The main reason is the removal of the income and growth on the gifted assets from the taxable estate.

For individuals who fully used their transfer tax exemptions in prior years, consideration should be given to making gifts of the additional inflation adjusted amount (i.e., the $90,000 increase in the transfer tax exemption from 2013 to 2014, and an additional $90,000 increase in the exemption from 2014 to 2015).

Benefits of Acting Early. The main benefit of making gifts that utilize the transfer tax exemption is to remove from the taxable estate the income and appreciation on those assets from the date of the gift to the date of death. The sooner the gifts are made, the more likely that additional income and growth on such assets will escape taxation.

Gifts in Trust. Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns are usually addressed by structuring the gifts in trust, which allows the donor to determine how the assets will be used and when the descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage. This is particularly effective when coupled with applying GST exemption to the trust (discussed above) and making the trust a “grantor trust” for income tax purposes (discussed below).

Many individuals may not be comfortable giving away significant amounts of wealth. However, the gift trust technique is not limited to trusts for descendants, but may also include a spouse as a beneficiary (or as the sole primary beneficiary).  Making the spouse a beneficiary of a gift trust (generally referred to as a spousal lifetime access trust, or “SLAT”) provides indirect access to the trust assets, while allowing the income and growth to accumulate in the trust (if not otherwise needed), and pass free of estate and gift taxes.

One of the most powerful estate planning strategies is the utilization of a “grantor trust.”  Significant additional transfer tax benefits can be obtained by structuring a gift trust as a “grantor trust” for income tax purposes. The creator (or “grantor”) of a “grantor trust” is required to report and pay the tax on the income earned by the trust. This allows the grantor to pass additional funds to the trust beneficiaries free of gift and estate taxes and income taxes, as the grantor’s payment of the trust’s income taxes each year would be considered his or her legal obligation and would not be considered additional gifts.

Taxable Gifts

Although individuals generally dislike paying taxes, making taxable gifts and paying a gift tax may prove to be beneficial.  While the federal government imposes a 40% estate tax on taxable estates and a corresponding 40% gift tax on taxable gifts, Illinois does not impose a gift tax. Thus, taxable gifts result in an overall savings of state estate and gift tax.  Moreover, the differing manner in which the gift and estate taxes are computed and paid results in overall transfer tax savings.

The gift and estate tax, although “unified,” work quite differently. The estate tax is “tax inclusive:” the tax is determined based upon the assets owned at death, and paid from those assets (similar to the income tax, which “after tax” dollars must be used to pay the tax). However, the gift tax is “tax exclusive:” the gift tax is determined based on the assets gifted, and paid from other assets owned by the donor. As an example, if you previously used your transfer tax exemption and then make a $1,000,000 gift you would incur a $400,000 gift tax, $1,400,000 will be removed from your estate, and the donees will receive $1,000,000.  However, if you die without making the $1,000,000 gift, you would have the full $1,400,000 included in your estate, resulting in approximately $676,000 of federal and Illinois estate taxes, leaving only $724,000 rather than $1,000,000 for your descendants. In order to leave $1,000,000 for your descendants at death you would need approximately $1,934,000. The estate tax on such amount would be approximately $934,667, leaving $1,000,000 for your descendants. Stated another way, by gifting assets the IRS gets 40¢ for each $1.00 your beneficiaries receive, but by dying with the assets the IRS gets 93¢ for each $1.00 your beneficiaries receive. However, there are also potential downsides: paying a tax earlier than otherwise may be needed, the possibility that the estate tax may be repealed or the rates reduced, the loss of income/growth on assets used to pay the gift tax, the possibility that the transfer tax exemption may be increased which would have allowed the gifts to pass tax free, etc.

Making Use of Historically Low Interest Rates

Interest rates remain very low (with increases likely on the horizon). The current (and historically low) interest rates continue to create an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis.  Techniques such as grantor retained annuity trusts (“GRATs”), charitable lead trusts (“CLTs”), intra-family loans (bearing the minimal interest in order to avoid a gift of 0.39% for loans of 3 years or less, 1.90% for loans of 3 to 9 years, and 2.91% for loans of 9 years or more as of November 2014), and sales to “grantor trusts” are sensitive to interest rate changes – and are very beneficial in a low interest rate environment.

Illinois QTIP

Given the disparity between the $5,340,000 federal estate tax exemption and the $4,000,000 Illinois estate tax exemption, married couples domiciled in Illinois should make certain that their estate plans are structured to take advantage of the Illinois QTIP marital deduction.  Otherwise, an estate plan that is designed to fully utilize the federal $5,340,000 exemption can inadvertently cause a $382,857 Illinois estate tax upon the death of the first spouse.

Net Investment Income (Medicare) Tax

Higher-income-earners should also plan for the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals earning in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately.) While the 0.9% additional tax on wages is only imposed on individuals, the 3.8% tax on net investment income is imposed on individuals, estates and trusts. Individuals are only subject to this new 3.8% Medicare tax if their “modified adjusted gross income” exceeds $250,000 for joint filers ($125,000 for a married individual filing a separate return) and $200,000 for single individuals.  In 2014, trusts and estates are subject to this tax at a $12,150 threshold ($12,300 in 2015). The approach to minimizing or eliminating the 3.8% surtax depends on each taxpayer’s individual situation. Some taxpayers should consider ways to minimize (e.g., through deferral) additional net investment income for the balance of the year, while others should review whether they can reduce modified adjusted gross income other than unearned income. In contrast, others may want to accelerate net investment income and/or modified adjusted gross income that would be received next year so that it is included this year (e.g., to take advantage of deductions this year). Year-end planning (such as timing the receipt of net investment income, the receipt of modified adjusted gross income and the payment of deductible expenses) can save significant taxes.

Retirement Plans and Beneficiary Designations

Contribution limitations for pension plan and other retirement accounts for 2015 were recently released by the IRS.  The following adjustments were triggered by an increase in the cost-of-living index:

  • Elective deferral contribution limits for employees who participate in a 401(k), 403(b) and 457(b) plans increased from $17,500 in 2014 to $18,000 in 2015.
  • The catch-up contribution limit for employees (aged 50 or older) who participate in a 401(k), 403(b) and governmental 457(b) plans increased from $5,500 in 2014 to $6,000 in 2015.

The end of the year is a good time to review the beneficiary designations on your pension plan and other retirement accounts (as well as life insurance policies).  Failing to name beneficiaries or keep designations current to reflect changing circumstances can create substantial difficulties and expense (both emotionally and financially) – and may lead to unintended estate, gift and income tax consequences.  You should make certain to designate beneficiaries when participating in a new retirement plan and update beneficiary designations when circumstances dictate (e.g., death of a spouse).  Finally, it is prudent to maintain a current list of accounts with beneficiary designations – which specifies the type of asset, account numbers, account custodians/administrators and beneficiaries designated for each account (primary and contingent).

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Lessons Learned about Real Estate Lending in this Last Recession

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We all know real estate, and especially real estate lending, was heavily affected by the recession. Now that banks are starting to lend again, what can we learn from those bad years to set us on a better course for the future?

1. Real estate lending in the last cycle. We learned problem loans arose principally on loans with high loan to value ratios, or based on projections that were too optimistic, or in geographic markets where the lender did not have good market knowledge, and especially where the bank became more of a joint venturer with the developer. Smaller community banks especially felt more pressure to help home grown companies expand.

2. Problems exposed in the recession and recovery.

  • Appraisal methodology. Through the hard lessons of foreclosure and bankruptcy we learned more acutely about appraisal methodology, and the weaknesses of this methodology in troubled times became transparent. We learned that, although appraisers are not supposed to take “forced sales” into account in calculating fair market value, when the market is thin, “forced sales” may be the only comparables.
  • Exercise of developer’s rights. We also learned a developer’s decisions can have a drastic impact on a lenders’ ability to recover collateral, and on holding costs during workout or foreclosure. This was especially clear in cases where a condominium developer suddenly expanded the condominium into future phases, even when units were not selling, thus creating many separate tax key numbers with separate real estate tax bills, separate condominium association assessments, and no means of reversing that decision except with unanimous or near-unanimous consent of all condo unit owners and their lenders.
  • Interstate Land Sale Act. Condo unit buyers attempting to cancel contracts to purchase condos whose value had fallen, started using the long-dormant Interstate Land Sale Act as a weapon, with increased liability to developers.
  • Priority of municipality’s rights under development agreements. The Baylake Bank case in Wisconsin highlighted the ability to challenge the priority of charges and obligations contained in municipal development agreements.
  • Drastic impacts to condominium and homeowners’ associations’ budgets. Failure of even a small percentage of condo unit owners or homeowners to pay their assessments resulted in grave difficulties in that association’s ability to function.
  • Foreclosing on less than all needed assets of a project. Lenders foreclosing on projects discovered they lacked the ability to make needed changes in the project to facilitate its resale and needed to negotiate with their delinquent borrowers to secure Declarant rights reserved in condo declarations, permits issued only in the borrower’s name, and necessary easements.

3. Reaction to market risks. In response to these risks exposed in the recession, parties in the real estate market took action.

  • Title insurance changes. In reaction to the sudden increase in title claims, title companies not only increased their fees substantially, but also reversed their practice of deleting the “creditor’s rights” exception in their policies.
  • Secondary mortgage market changes. In response to liability claims, Fannie Mae, Freddie Mac, the Department of Veterans Affairs and others modified their requirements for purchase of loans from primary lenders, which changed requirements for condominium declarations and strongly encouraged phasing of projects.
  • Lending changes. Lenders are now under more scrutiny and stiffer governmental oversight on all real estate loans.

Those of us who are involved in the commercial real estate world hope we are starting on a new cycle of expansion. However the “hangover” of this recession will require us to change our documents and practices for success in this new period.

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