Category: Real Estate

Tax Court Holds that a Trust can Qualify for the "Real Estate Professional Exception" of Section 469(c)(7)

Proskauer

The Tax Court recently handed down its decision in Frank Aragona Trust v. Commissioner, ruling that a trust can qualify for the real estate professional exception of Section 469(c)(7). By taking into account the actions of the trustees, a trust can be considered to be materially participating in real estate activities. This means that losses from real estate activities can be treated as nonpassive and therefore deductible in determining the trust’s taxable income. This decision is especially relevant to trusts that own business as it affects the application of the passive activity loss rules in Section 469 and whether income from those activities is subject to the new 3.8% net investment income Medicare surtax under Section 1411.

The Frank Aragona Trust (the “Trust”) was a Michigan trust that owned several pieces of real property and was also involved in the business aspects of developing and maintaining the property. The Trust had six trustees, three of whom were also employees of Holiday Enterprises, LLC (the “LLC”). The LLC was owned 100% by the Trust. The LLC also employed other professionals.

The Trust had losses in 2005 and 2006 from its real estate activities and deducted those losses(on the basis that they resulted from nonpassive activities) on its income tax returns. In issuing a notice of deficiency for those tax years, the Service determined that the real estate activities were passive under Section 469 and therefore any related losses were not deductible.

In general, real estate rental activity is considered passive regardless of whether the taxpayer materially participates in the real estate business. However, there is an exception for “real estate professionals” under Section 469(c)(7). Before the Tax Court, the Trustees argued that the Trust was a “real estate professional” as defined in Section 469(c)(7) so that the losses were considered to be from nonpassive activities and therefore deductible. To qualify for the real estate professional exception, a taxpayer must pass two tests. First, more than one-half of the personal services performed in a taxable year must be performed in real property trades or businesses in which the taxpayer materially participates. Second, the taxpayer must perform more than 750 hours or services during the taxable year in real property trades or businesses in which the taxpayer materially participates. The Service argued that the regulations to Section 469(c)(7) define “personal services” as “work performed by an individual in connection with a trade or business [emphasis added].” Because the trust was not an individual, it could not perform personal services and therefore did not fall under the Section 469(c)(7) exception.

The Tax Court rejected the Service’s argument that the trust could not be considered an individual under Section 469(c)(7) and the associated regulations. Further, the Court found that the Trustees’ participation in the real estate activities met the material participation requirements of Section 469(c)(7) because they were regular, continuous and substantial. The Court determined that the participation of the Trustees should be considered in determining whether the taxpayer (the Trust) materially participated in the real estate activities. The Service argued that the activities of the Trustee should only apply if they are performed in their capacity as Trustees (as opposed to employees of the LLC). Here, the Court looked to Michigan law, under which trustees are required to administer trusts solely for the benefit of the trust beneficiaries. The Court explained that the Trustees could not simply stop acting as Trustees because they were also employees of the LLC, so that their activities in other capacities could be considered in whether the Trust was a material participant in the real estate activities.

In summary, a trust may be able to qualify for the real estate professional exception of Section 469(c)(7). If the trust qualifies for the exception, losses from the associated real estate activities may be deductible on the trust’s income tax return. This distinction has increased importance with the application of the new 3.8% net investment income Medicare surtax under Section 1411.

Article By:

Albert W Gortz
George D Karibjanian
David Pratt
Mitchell M Gaswirth
Andrew M Katzenstein
Henry J Leibowitz
Of:
Proskauer Rose LLP

 

Economic Impact of Homebuilding and Remodeling

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Blocked streets, noisy construction and unwelcome trash can be just a few of the inconveniences that come along with a neighbor’s new home construction or home remodeling. However, a report released in early May by the National Association of Homebuilders (NAHB) confirms that for the overall good of the nation’s economy, some of these inconveniences may be worth the hassle.

Residential home building is back, and it’s helping the economy in a big way

The NAHB’s report calculated the approximate number of jobs that are created and how much tax revenue is generated relative to the different types of residential construction projects. It found that the construction of an average single-family home creates approximately 2.97 jobs and generates approximately $111,000 in taxes per home. Not having quite as significant of an impact, but still highly beneficial to the economy, are rental apartment construction projects, which create roughly 1.13 jobs per unit and generate approximately $42,000 in taxes per unit. In generating these statistics, the NAHB defined a “job” as work that can keep one worker employed for an entire year based on an average number of hours worked per week in the homebuilding industry.

homesA robust homebuilding market has wide-reaching benefits. In addition to the workers in a variety of construction and remodeling industries, including lumber, concrete and HVAC, other beneficiaries include workers that transport homebuilding materials and products, as well as those in the service sectors, such as architects, engineers, real estate agents, lawyers and accountants.

This latest report is the first update to the NAHB’s National Impact of Home Building estimates since 2008. Interestingly, the statistics related to tax revenue and jobs-per-housing-unit are roughly equal to what they were in the 2008 report, but the NAHB article indicates that that is likely due to inflation, changes in housing preferences and the use of somewhat revised metrics in determining these estimates.

Can the Town Make Me Change My Sign?

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A business’ signage can be one of the most distinctive characteristics of its brand and one of its most important assets.  This is especially true when the sign display’s the business’ federally registered trademark and color is a feature of the mark.  But what happens when that brand runs afoul of state and local laws?

It is common place for commercial real estate development plans to impose requirements on the characteristics of the signs that tenants may display in the development.  Sometimes, those requirements impose restrictions on the colors that such signs may display.  For owners of federally registered trademarks where color is claimed as a feature of the mark, the last thing they want is to have to change the color of their sign.

For example, imagine telling McDonalds that its famous golden and red sign must be displayed in other colors, say, like this:

McDonalds Logo w Inverted Colors

For most consumers, I suspect this sounds ridiculous.  But that is exactly the obstacle that federal brand owners must overcome when faced with local zoning restrictions on color.

Fortunately, the federal trademark law provides some relief.  Or does it?   The Lanham Act expressly provides that federal law preempts state law by providing (in part):

No State or other jurisdiction of the United States or any political subdivision or any agency thereof may require alteration of a registered mark …. (15 USCA §1121(B))

While this may seem pretty clear on its face, courts are split as to whether towns can lawfully impose color restrictions on signs displaying a federally registered trademark.

Two courts in the 9th Circuit (including the 9th Circuit Court of Appeals) have shot down Tempe, Arizona’s attempts to impose such color restrictions under this section of the Lanham Act.  Blockbuster Videos, Inc. v. City of Tempe, 141 F.3d 1295 (1998); Desert Subway, Inc. v. City of Tempe, 322 F. Supp.2d 1036 (2003).  Conversely, two courts in the 2d Circuit (including  the 2d Circuit Court of Appeals) have upheld town zoning boards’ imposition of signage color restrictions as superior to the rights of federally registered trademark holders.  Payless Shoesource, Inc. v. Town of Penfield, NY, 934 F. Supp. 540 (1996); Lisa’s Party City, Inc. v. Town of Henrietta, 185 F.3d 12 (1999).

According to the 9th Circuit courts, from looking at the legislative history, it is clear that while local governments can prohibit the display of outdoor signs altogether, there is nothing to suggest that local zoning ordinances may require alteration of trademarks.  Looking at the identical legislative history and, in some cases, quoting from the same testimony, the 2d Circuit courts agreed that the law would allow local zoning ordinances to prohibit outdoor signs altogether or even materially restrict their size.  However, the 2d Circuit found that the statute was intended to prohibit state-mandated changes in the trademark  itself since the brand owner would be free to use the unaltered mark in every other aspect of its business.

So who is right?

Like any other situation where courts are split geographically, they both are.  Until the Supreme Court takes up the issue, local ordinances in the 2d Circuit are free to place restrictions on colors used in trademarks displayed on signs, whereas in the 9th Circuit (especially, Tempe, Arizona), local ordinances may not.  For those of us in other circuits, the moral of the story for brand owners is to be mindful of local zoning restrictions before committing to a store location.  Real estate developers should also be mindful of signage restrictions included in their plans when seeking local approvals.

Article By:

Kurt E. Anderson
Of: 
Giordano, Halleran & Ciesla, P.C.

Good News for Grove Isle Condo Owners – Miami

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Grove Isle condo owners, who have been in the middle of a battle over a proposed 18-story condo tower which will replace the low-rise Grove Isle Hotel & Spa, received some good news when the Third DCA overturned the dismissal of Grove Isle Association’s 2009 lawsuit against the owners and former and present managers of Grove Isle’s Club.

condoIn that lawsuit, the Association brought claims for injunctive and declaratory relief, unjust enrichment, and breach of contract, claiming, among other things, that the enjoyment of the Club’s amenities (a restaurant and lounge, private banquet room, health spa, swimming pool and tennis courts) was limited to private members of Fair Isle, and seeking an order prohibiting the defendants from allowing unauthorized members of the public to use the Club’s amenities.  The Association also maintained that it was unfair and unreasonable to require the condo owners to bear all the costs of maintenance, management and operation of Fair Isle’s facilities, amenities and common areas (including the bridge that spans Biscayne Bay and connects Miami with Grove Isle’s private island resort), even though these areas are also used by other Fair Isle guests.  Therefore, the Association sought to recover the value of its maintenance, management and operation payments over the years.

In overturning the trial court’s decision, the Third DCA held that the lawsuit was improperly dismissed based on a statute of limitations defense, where the trial court could not determine from the four-corners of the complaint the date in which the alleged causes of action accrued. Specifically, the Third DCA found that it could not affirmatively be determined from the face of the complaint when allegedly unauthorized members of the public began using the Club’s amenities or whether the payment of assessments dating back to 1979 related to the use of the Club’s amenities by certain unauthorized members of the public.  However, the Third DCA stated that the statute of limitations would bar plaintiff’s claims if the claims accrued before July 2004.

The Third DCA also emphasized the general policy of allowing a plaintiff leave to amend the complaint at least once, in an attempt to state a cause of action, unless it is clear that a plaintiff cannot in good faith allege a set of circumstances sufficient to state a cause of action, and found that the trial court’s dismissal of the Association’s first complaint with prejudice was an abuse of discretion.

Now that the Association may move forward with its lawsuit, it is unclear what the Association’s course of action will be.  What is clear, however, is the interesting situation that the Grove Isle owners are now facing.  This lawsuit deals with the private versus public use of the Club’s facilities and the Association’s responsibility for the payment of total costs and expenses for maintaining, managing and operating the facilities and common areas.  Now with the proposal of replacing the hotel with a private condo tower, many of the condo owner’s concern should be ameliorated, as this proposal means that the private island would only be open to owners, renters and visitors, rather than members of the public who currently have access to the private island due to the amenities offered by the hotel and spa.

Article By:

Enza G. Boderone
Michael N. Kreitzer
Of: 
Bilzin Sumberg Baena Price & Axelrod LLP

The Effect of On-line Shopping on Retail Leases and Percentage Rent

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“Percentage Rent” is a familiar concept to retailers and landlords and has long formed a significant aspect of the business arrangement between commercial landlords and their retail tenants.  In a lease arrangement that includes percentage rent, a landlord may negotiate a relatively reduced base rent for the chance to have some “skin in the game” by agreeing to participate in a percentage of tenant’s revenue, through gross sales, when that revenue exceeds a certain threshold amount.  Tenants appreciate this arrangement because they pay percentage rent if they are doing well and their sales exceed that negotiated threshold level. Landlords appreciate this model because it compensates them for the costs they incur in creating and maintaining successful shopping centers with amenities, such as food courts and open spaces.  If a successful shopping center drives foot traffic to individual tenants that increases their sales, tenants are often willing to compensate landlords for their part in driving that foot traffic.  The concept really is a “rising tide lifts all boats” model, in which landlords and tenants work as partners.

The explosion of on-line shopping throws a wrench into this scheme.  With more people purchasing from retailers on-line, and more retailers encouraging customers to place orders on-line, how will retail leases with percentage rent provisions be affected? Many percentage rent leases are carefully crafted to limit the types of sales that count toward the revenue in which landlord shares, often by including as only those sales “made from the store.”  The question to consider: if a large percentage of a store’s sales are made on-line, can or should those sales be treated as made from, or initiated in that store, such that the landlord will be entitled to a percentage of such sales?

It is clear that out of stock items unavailable during a customer’s visit to a store, but ordered at the store and delivered directly to the customer’s home should be counted toward gross sales at that store and counted toward the percentage rent calculation.  Similarly, on-line sales made at a computer terminal in the store, or on-line sales made at the customer’s home and picked up at the store should also be counted.  It becomes much less clear when a customer never sets foot in the store itself in either placing an order or receiving goods.  It may be difficult for a landlord to assert their right to a percentage of an on-line sale made by a customer in their home where the merchandise is then delivered directly to that customer’s home where the transaction occurs without any contact with the store premises.

As traditional retail stores work to accurately account for on-line sales with their landlords, another issue has recently emerged.  Traditional on-line only merchants such as Amazon have seen a potential benefit of having a brick and mortar presence to market their business and may soon open physical locations.  The question of percentage rent may become even more difficult to account for when the store front is really merely a marketing device to drive customers to company websites.

A thoughtful balance should be found to properly compensate Landlords for the sales they are driving to retailers. At the same time, from tenant’s perspective retail leases must be carefully drafted to exclude sales that are not derived from a particular store.  If this balance is struck properly, landlord/tenant partnerships will be well positioned for success in the retail and commercial real estate markets.

Article By:

Geoffrey H. Smith
Of: 
Sherin and Lodgen LLP

"Rails to Trails" or "Rails to Trespass": Supreme Court Speaks on the Abandonment of Certain Railroad Rights of Way

Womble Carlyle

Last month, the Supreme Court of the United States (please, there is no such thing as the “United States Supreme Court”) decided a very interesting case about easements.  “Easements?”, you ask.  Yes, easements.  We use them almost every day.  Well, every weekend, perhaps.  Greenways.  Rails to trails.  Beach access.  You name it.  Also, the case is interesting because it holds the Federal Government to a much older (1940-old, which is old) argument it made about easements, and which contradicts the Government’s argument in this recent case.

We’re talking today about Marvin M. Brandt Revocable Trust v. United States, No. 12-1173 (March 10, 2014).

Facts.

In 1875, to encourage settlement of the West and to entice railroads to develop, Congress passed the General Railroad Right-of-Way Act, which granted to “any railroad” a “right of way through the public lands of the United States” to the “extent of 100 feet on each side of the central line” provided the railroad either (1) actually constructed its railroad or (2) filed a proposed map of its rail corridor.  From that day forward, after the right of way is obtained, “all such lands over which such right of way shall pass shall be disposed of subject to the right of way”.

In 1908, pursuant to the Act, the Laramie[,] Hahn’s Peak & Pacific Railway Company obtained a 66-mile, 200-foot wide right of way through southern Wyoming.  By 1911, the Railway had completed construction of its railroad over the Act-granted right of way.

In 1976, the United States patented an 83-acre parcel to the Brandt family, conveying fee simple title but reserving and excepting certain rights-of-way and easements “to the United States”.  For purposes of our discussion today, we’ll focus on the reservation and exception that the land was patented “subject to those rights for railroad purposes as have been granted to the Laramie[,] Hahn’s Peak & Pacific Railway Company.”  That right of way stretched for nearly 1/2-mile across the Brandt parcel, covering 10 of the 83 acres.  As noted by the Court, “[t]he patent did not specify what would occur if the railroad abandoned this right of way”.

The rail line owning the right of way changed hands a number of times, ending with the Wyoming and Colorado Railroad.  In 1996, the Railroad notified the Surface Transportation Board of its intention to abandon the right of way.

The Lawsuit.

In 2006, the United States filed this lawsuit seeking a judicial declaration that the right of way had been abandoned and an order quieting title to the right of way in the United States.  All property owners along the right of way settled or defaulted but for the Brandts, which took issue with the attempt to quiet title in the United States.

The Brandts contend that the “stretch of the right of way crossing [the Brandt] family’s land was a mere easement that was extinguished upon abandonment by the railroad, so that, under common law property rules, [the Brandts] enjoyed full title to the land without the burden of the easement”.

The United States “countered that it had all along retained a reversionary interest in the railroad right of way—that is, a future estate that would be restored to the United States if the railroad abandoned or forfeited its interest”.  In this sense, the United States is arguing that the 1875 Act created something more than an easement, the latter working as the Brandts indicate.  It is this “implied reversionary interest” in the United States that underlies the dispute.

The trial court granted summary judgment to the United States, and the appellate court affirmed.  The Supreme Court granted certiorari, and reversed.  In an 8-1 decision, the Court determined the Brandts held title to their 83 acres free and clear of the abandoned easement.  The other landowners are SOL.

The Majority.

The Majority’s decision sits on two pillars: (1) the common law nature of easements and (2) an earlier argument from the United States’, on which the United States succeeded, that supports the Brandts’ position and contradicts the United States’ position in this lawsuit.

First, the common law nature of easements.  Citing myriad secondary sources, the Court notes that an easement is a “nonpossessory right to enter and use land in the possession of another”, which “disappears” if the beneficiary “abandons” at which point “the landowner resumes his full and unencumbered interest in the land”.  Thus, the railroad’s decision to abandon and ruling that it had abandoned “resume[d]” in the Brandts their patented interest in the property.

Second, the United States’ inconsistency.  In what appears to be a point of order first raised before the Supreme Court — there is no mention of this at either the trial court or the appellate court level — the Court notes that the United States argued successfully in 1940, adopted by the Court “in full”, that the 1875 Act “clearly grants only an easement, and not a fee”.  See Great Northern Railway Co. v. United States, 315 U.S. 262 (1942).  Thus, the United States cannot now argue that the 1875 Act creates something more than an easement, with an implied reversionary interest in the United States after abandonment.  Of course, if you’re the United States, there is likely nary an argument you haven’t made before.

 The Dissent.

The dissent takes the position that railroad rights of way have always been treated differently than ordinary easements, and rightfully so, as sui generis property rights not governed by the common law regime.  In the context of railroad rights of way, the dissent points out, “traditional property terms like ‘fee’ and ‘easement’ do not neatly track common-law definitions” as the rights of way have characteristics of both easements and fee.  The dissent insists that precedent, including the decision in Great Northern Railway, is clear that railroad rights of way were granted by the 1875 Act “with an implied possibility of reverter in the United States”.

And then the dissent gets real, which is our jam:  “By changing course today [from prior precedent regarding railroad rights of way and implied reversionary interests in the United States], the Court undermines the legality of thousands of miles of former rights of way that the public now enjoys as means of transportation and recreation.”  Yep, those trails, which had been rails, could likely fail.

rails to trails
“Trespass your way around Town by bike, jog, or stroll.”

Article By:

Michael C. Thelen
Of:
Womble Carlyle Sandridge & Rice, PLLC

 

U.S. Tax Court Rejects Internal Revenue Service's (IRS) Restrictive View of Trust Material Participation

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The U.S. Tax Court recently issued a taxpayer favorable opinion regarding how a trust materially participates in its activities. The court’s holding will make it easier for trusts to currently deduct expenses against non-passive income and to exclude income from the reach of the new 3.8% net investment income tax.

In Frank Aragona Trust v. Comm’r, the court held that in determining whether a trust materially participates in its activities, the activities of the trustees, including their activities as employees of the businesses owned by the trust, should be considered. The court’s opinion directly conflicts with recent IRS guidance that only a trustee’s time spent acting in a fiduciary capacity counts toward the trust’s material participation – a standard that would be very difficult for most trusts to meet. See Technical Advice Memorandum 201317010.

In Frank Aragona Trust, a Michigan trust owned rental real estate activities and engaged in holding and developing real estate. The trust conducted some of its activities directly, and others through its wholly-owned business, Holiday Enterprises, LLC. The trust had six trustees, three of whom worked full-time for Holiday Enterprises. The IRS argued that the participation of the trustee-employees should be disregarded. The court disagreed and concluded that the participation of the trustee-employees should be counted and further, that the participation of the trust’s six trustees was sufficient to meet the material participation standard. The court based its decision, in part, on the fact that Michigan law requires trustees to “administer the trust solely in the interest of the trust beneficiaries” even when they are participating through a business wholly-owned by the trust. This decision provides helpful authority for trusts, their trustees and their advisors in navigating the complex passive activity loss and net investment income tax rules.

However, the decision in Frank Aragona Trust does not answer all of the outstanding questions regarding material participation of trusts. In recently finalized regulations implementing the net investment income tax, the Treasury Department and the IRS requested public comments on rules regarding material participation of trusts, which indicates that the IRS may finally undertake a formal project to provide long-awaited guidance on this issue.

Article By:

Michala P. Irons
Randal J. Kaltenmark
William M. Pope
Douglas S. Robson
Howard J. Rubin
Of:
Barnes & Thornburg LLP

Retail Shopping: Virtual or Reality?

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In the 1998 movie, “You’ve Got Mail,” the charming children’s bookshop owned by Meg Ryan’s character is threatened by the mega-box book store owned by Tom Hank’s character. Despite the small shop’s long history as a part of the Main Street USA-style neighborhood, the store eventually folds underneath the pressure exerted by the discount powerhouse next door. Flash forward to 2014, and Borders book stores have closed their doors due in large part to Amazon.com’s supremacy in the sale of on-line books. According to Bloomberg News, in December 2013, “Cyber Monday web sales surged, sending online shoppers to a single-day record as Amazon.com and EBay, Inc. siphoned customers from brick and mortar stores.” At first glance, it seems like there’s only bad news for traditional retail shops.

Retail Shopping You've Got Mail

But here’s some good news: physical shopping centers can compete with the convenience of one-click online shopping by offering the right combination of stores, services, restaurants and entertainment that will draw consumers to live retail destinations.

Consumers will be more likely to shop in brick and mortar stores for products they want to touch and try out first hand, such as beauty products by Sephora, home furnishings by Boston Interiors, or high end clothing.  Specialized fitness studios such as yoga studios or indoor cycling classes and luxurious salon and spa services will also attract even the most avid online shoppers.

In addition, many new outdoor centers offer more immersive options than the traditional strip center or enclosed mall: These so-called “urban villages” feature amenities and entertainment venues such as walking boulevards, outdoor plazas for concerts, retro bowling alleys, ice skating rinks and even life-size Chess boards. In addition, many of the new centers offer a wide range of culinary options to satisfy every craving, from an elegant first-class steakhouse to a casual French bakery and cafe — the perfect place to indulge in a sidewalk cappuccino or chocolate croissant. Chain restaurants and discount stores strung along the highway don’t stand a chance against a restaurant or boutique located in one of these vibrant centers. These shopping hubs often have plenty of space and facilities for special events: restaurants can host celebrity chef events, and the outdoor spaces can accommodate fashion shows, fine art performances, art shows and other seasonal and community events.

By offering products and services that people prefer to buy in real life and by creating destination centers where friends and families will flock to shop, eat, socialize and have fun, the experience of shopping on Main Street USA will surely remain an integral part of the future of retail.

Article by:

Jane Errico

Of:

Sherin and Lodgen LLP

It’s That Time of the Year Again Re: Wisconsin Property Taxes

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It’s time to open up the unwelcome envelope with your property tax bill inside. Property taxes are necessary, of course, for roads and schools and all of the other services your property receives, but you should take some time to make sure that you are not paying more than your fair share of these taxes.

Wisconsin’s State Constitution has a provision requiring that all real estate be taxed “uniformly.” Regular real estate and personal property is taxed by the local municipality. Property which is used for manufacturing purposes, is taxed by the State of Wisconsin, in an effort to make sure that manufacturing property throughout the State is taxed in the same manner. Land which is in agricultural use enjoys a separate “use value assessment” system, which not only allows a lower assessment for land in that use, but also requires a per-acre penalty if that land is removed from the ag use, as defined by those statutes.

Of course, each of those taxing categories is controlled by pages of regulations containing definitions and limitations which are too complicated to insert into this article. Be aware that if you bought a parcel during calendar year 2013, your tax assessment may rise next year to the sale price named on the Transfer Tax Return filed with that deed, and you will receive a notice next spring of that increased assessment. The notice will tell you the procedure for contesting that new higher assessment and the time period, usually very short, during which you must file an appeal or lose the opportunity for another year. However, if your tax assessment should have been reduced and was not, you might not receive a notice at all, which means you must affirmatively seek out the date for filing the tax challenge and the forms needed to preserve the right to challenge. You must affirmatively notify the assessor if you demolished a building, lost a tenant, suffered a casualty loss, signed new leases for lower rents or had to offer rent concessions to renew a lease, or moved a parcel of land into or out of ag use, if you want to be sure the tax assessment is properly calculated for the actual use of the land and actual income from it. We can help you evaluate behind the scenes if the property is accurately assessed, and if it is not, file and defend a claim for you. We often charge a nominal amount for the investigation and then take the tax challenge on a contingency basis so you are only billed if we secure a tax savings for you.

Article by:

Nancy Leary Haggerty

Of:

Michael Best & Friedrich LLP

JPMorgan Chase Pays $614 Million for Submitting False Claims in Mortgage Loans Case

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The Department of Justice (DOJ) announced last week that JPMorgan Chase, the largest bank and financial institution in the country, will pay a $614 million settlement to the US government to resolve allegations that it approved thousands of unqualified home mortgage loans for government insurance and refinancing. According to the DOJ, JPMorgan knowingly created and guaranteed non-compliant mortgage loans submitted for insurance coverage by the Department of Housing and Urban Development’sFederal Housing Administration (FHA), and the Department of Veterans Affairs (VA), which cost the government millions of dollars when the loans defaulted.

According to the lawsuit, beginning in 2002, JPMorgan falsely claimed that loans it had created and guaranteed were qualified for FHA and VA insurance and coverage.  As a consequence of JPMorgan’s falsifications, both the FHA and the VA incurred huge monetary losses when the unqualified loans failed, due to the fact that the FHA and VA had to cover the associated losses of the loans.

The FHA’s program allows lower income borrowers to purchase homes by insuring qualified loans made by participating lenders, such as JPMorgan, against losses if the loans later default.  However, a participating lender may only submit creditworthy loans to the FHA if they meet certain requirements and they must maintain a quality control program that can prevent and correct any deficiencies in the lender’s financing practices.  The VA’s program is similar in this regard—it provides similar assistance to veterans, service members and spouses.

JPMorgan allegedly approved thousands of loans for government insurance or refinancing that did not meet the requirements of the FHA and VA, and also failed to report hundreds of loans it identified as having been affected by fraud or other defects. The government also alleged that the bank regularly submitted loan data that lacked reliability, due to the fact that they were not based on actual documents or other information the bank should have possessed when its employees submitted the data to the government.

As part of the settlement, JPMorgan admitted that it approved thousands of FHA loans and hundreds of VA loans that were not supposed to be eligible for FHA or VA insurance because they did not meet the applicable agency financing requirements, and that it had been doing so for over a decade.  The bank further admitted that it failed to inform the FHA and the VA when its own internal reviews discovered more than 500 unreliable loans that never should have been submitted for FHA and VA insurance.

This settlement resolves allegations in a complaint filed by a private whistleblower.

If you have information concerning a potential case involving banking fraud, do not hesitate to take action. It is possible that you might be able to bring your own lawsuit under the False Claims Act, acting as a whistleblower on behalf of the US government.

Article by:

Whistleblower Practice Group

Of:

Tycko & Zavareei LLP