Saturday, January 29, 2011

Deposit Disputes; How can transaction parties avoid earnest money conflicts?

by Andrew Maguire

Part of the toll of the ongoing commercial real estate slump is the high frequency of terminated deals. Scarcity of financing, valuation disconnects, and general economic concern all contribute to the “kill rate.” Of course, any time a deal is terminated, the earnest money deposit must be released by the escrow holder in accordance with the agreement of sale. But what happens if the agreement of sale does not clearly state which party should get the deposit?

Who Gets the Money?

Compared with residential deals, where consumer protection laws might trump the express language of the contract, courts are more likely to enforce the unambiguous agreement terms in commercial transactions. However, when a commercial transaction is terminated and the agreement is silent or ambiguous as to which party should get the deposit, the presiding judge is forced to make that decision.

In Wawa, Inc. v. Insnetvest Corp., a recent Philadelphia trial court case, the buyer and seller under a terminated purchase agreement each sought the entire $150,000 escrowed deposit. The purchase agreement gave the buyer the right to terminate if it could not obtain necessary conditional-use approvals at an “acceptable” cost. Although the buyer’s application for conditional-use approvals was approved — subject to the satisfaction of certain conditions — the buyer elected to terminate, maintaining that it was not cost effective to proceed to closing.

The purchase agreement between Wawa and Insnetvest did not state which party would get the deposit if the buyer terminated for cost-based reasons, leaving the trial judge to make that determination. The judge ruled that Wawa properly terminated the agreement of sale and held that the termination constituted a “rescission” of the contract. The object of rescission is to return the buyer and seller to the position that each occupied prior to signing the contract. Although the parties to a terminated agreement of sale can never truly return to their pre-contract positions (for example, how can the seller get back the time it lost while its property was under contract), the court determined that the buyer should recover its entire earnest money deposit.

Similarly, a 2010 California appeals court decision affirmed the rescission of an agreement of sale in Sharabianlou v. Karp. In that case, a prospective commercial property buyer brought an action to rescind the agreement after the transaction failed to close on time. After it found certain deposit release language in the agreement of sale to be ambiguously drafted, the Sharabianlou court awarded the full escrowed deposit to the buyer.

Practical Considerations

Transaction participants should heed the following guidelines to avoid deposit disputes.

Clear contract terms.

The purchase contract needs to clearly spell out what happens to the earnest money deposit upon termination on specific grounds. The contract, and any amendments to the contract, also must specify whether additional deposits are to be handled the same as the initial earnest money deposit if termination occurs.

Competent counsel.

Before entering into a commercial agreement of sale, even the most cost-conscious sellers and buyers should hire competent counsel — the alternative could end up being far more costly. In the Sharabianlou case, a commercial broker — not a lawyer — drafted the ambiguous amendment that led to the rescission of the agreement of sale and, ultimately, a lawsuit against the broker.

Generally worded termination letters.

As a rule of thumb, termination notices should broadly reference the rights of the terminating party to cancel the deal. If the termination letter gives one specific justification for termination (without citing other legitimate grounds for cancelation) and a court later rules the lone justification to be invalid, the terminating party might find itself bound under a contract that it could have otherwise properly terminated.

Unbiased escrow holder.

Deposit holders generally are regarded to have a fiduciary duty to both buyer and seller. However, neutrality can be compromised when the deposit is held by an attorney, broker, or other agent for one of the parties to the transaction. Typically, title companies work well as escrow holders, as long as the agreement of sale provides that the escrow-holding title agent must be acceptable to both buyer and seller. As a general rule, any deposit holder should require buyer and seller to sign an escrow agreement indemnifying the deposit holder.

Matters concerning contract termination and deposit release vary by state law and are highly fact-dependent. Any buyer or seller involved in a deposit release dispute should obtain appropriate representation.

Sunday, January 23, 2011

Paying the Handyman? The IRS Wants to Know

Article by John Compagno,

If you're the owner of even just a single unit of rental property, starting in 2011 you must begin tracking any vendor doing at least $600 worth of work for you, because you now have to send them an IRS 1099 Form for the 2011 tax year – or face stiff penalties.

The requirement to track vendors and issue the 1099 forms isn't new. It's something larger rental property owners already do. But last year, when the federal government enacted the Small Business Jobs and Credit Act of 2010 (H.R. 5297), it expanded the requirement to all property owners, no matter how small. In effect, even property owners just doing rental as a sideline – maybe as part of a family investment fund or as part of a retirement savings plan – are "conducting a trade or business," so the 1099 reporting requirement now applies to them.

That means you have a legal obligation to obtain certain information from your vendors (generally, their name, address and Social Security number or other Tax ID, plus the amount you pay them over the year), and then issue them the 1099 forms to reflect the income you paid them for the year. (Don't forget to keep a copy for yourself.) Since the requirement takes effect for the 2011 tax year, you should start tracking the payments you make to your vendors beginning in January 2011. After you've tracked your payments for the year, you'll send them the total in the 1099 form in early 2012.

There are some exceptions to the requirement:

• Burden: if gathering the information and issuing the forms would create a hardship

• Duration: if the property is only a temporary rental of your own residence

• Income: if your income from the rental doesn't meet minimal threshold requirements

Additional Guidance to Come

More guidance is forthcoming. The IRS will fill in the details on what constitutes a hardship or is considered "minimal" income, so you'll need to watch for that when it comes out.

On the vendor side, the requirement applies to all independent contractors or freelance workers that typically provide services in a rental real estate context. These include plumbers, electricians, painters, cleaning services, gardeners, landscapers, accountants and handymen – in short, virtually all service providers to the property that don't receive a W-2 form from you and who provide at least $600 in services for the year. It's a cumulative amount, so even if that painting job only costs you $400, you need to track it and add any other charges from that vendor to see if the total comes to more than $600, which triggers the requirement for sending that vendor the 1099 form.

How to Comply

To satisfy the requirement, you'll want to review your bookkeeping procedures (with your accountant if you work with one) to be confident you have a system in place to track your payments to your vendors. You'll want to set up your tracking procedure so that you can keep separate how you paid them: by credit card, debit card, check or cash.

The IRS will set forth the important dates for the 2011 tax year. You'll want to note those and be sure to comply, because late filing will be penalized. Indeed, penalties have been doubled under the new law.

The initial first-tier penalty has been increased from $15 to $30 (filing 1099 up to 30 days late), the second-tier penalty increased from $30 to $60 (more than 30 days late), and the third-tier penalty increased from $50 to $100 (filing after August 1). There's also a $250 penalty for the intentional failure to file.
As a general matter, you'll be able to request a 30-day extension for getting your forms to the IRS, but that won't apply to your deadline for getting the form to your vendors. Remember, they need to use those in preparing their tax returns.
For many owners, the new reporting requirement will come as a surprise. If you manage property for a small owner, make sure you let them know about it. If you're the owner, be sure to prepare to comply, which means tracking your payments starting this year.

A version of this article will be published in the January 2011 issue of REALTOR® magazine.

The Author is with the offices of Holland and Knight, San Francisco

Saturday, January 8, 2011

The Ability to Expense Capital Costs (Section 179 Expensing) Now Includes Certain Real Property

By Paul J. Linstroth

For any tax year beginning in 2010 or 2011, a taxpayer may elect to treat up to $250,000 of qualified real property expenses as Section 179 property (subject to a phase-out). In other words, the taxpayer can take a current deduction for qualifying expenses as opposed to depreciating improvements over their useful life.

Qualified real property is:

(A) qualified leasehold improvement property (generally, improvements made pursuant to a lease by the lessor, lessee or sublessee, where the premises are occupied by the lessee or sublessee, and the improvements are made more than 3 years after the building was placed in service);

(B) qualified restaurant property (generally, a building or building improvements if more than 50% of the square footage is used for the preparation of, and seating for on-site consumption of, prepared meals); and

(C) qualified retail improvement property [generally, improvements to the interior of a building (excluding elevators, additions, structural framework modifications and common area improvements) used in a retail trade or business and such improvements are made more than 3 years after the building was placed in service].

The qualified property must be depreciable, acquired for use in the active conduct of a trade or business, and cannot be certain ineligible property (i.e., used for lodging, used outside the U.S., used by governmental units, foreign persons or entities, and certain tax-exempt organizations, air conditioning or heating units).

For purposes of applying the $500,000 expensing limitation for real and personal property, not more than $250,000 of the aggregate cost which is taken into account under Section 179 for any tax year can be attributable to qualified real property. The annual amount which may be expensed is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 and 2011 exceeds $2,000,000. In addition, the expensing deduction is limited to the taxpayer's taxable income but can be carried over to a subsequent taxable year. Notwithstanding the general carryover rule for expensing deductions, no amount attributable to qualified real property can be carried over to a tax year beginning after 2011.