Monday, July 28, 2014

Due Diligence Review: A Critical Step When Buying Real Property


It astonishes me how many buyers will buy real property without conducting a thorough review of the property before closing. Most buyers will ensure a title search is ordered and buy title insurance. If a recent survey or phase I environmental review has been conducted, the buyer will typically ask for and receive a copy from the seller, but frequently will not order a new (or updated) survey and/or environmental review unless a mortgage lender is involved who will require it.   

 

Even taking this minimal diligence review into consideration, time needs to be negotiated into the LOI and purchase agreement to allow for more due diligence.  While not all-inclusive, and recognizing that certain types of property warrant a closer look than others (e.g., industrial property),  below a bullet point list of other items (besides title and survey) for buyers to consider in a real property review. Which items on the list warrant a higher level of attention would be dictated by each property’s unique characteristics; provided that purchase price should not be the only factor controlling that decision. A cheap piece of property can cause a very expensive headache later if adequate diligence was not conducted prior to closing on the sale.

 

  • Litigation—Have the local court dockets where the property is located, plus where the seller is headquartered, to ensure no litigation is pending that could hinder seller’s ability to close or buyer’s ability to obtain clear title.
  • Environmental—Besides the standard Phase I review, other items that may warrant investigation depending on what the buyer intends to do with the property after closing are conducting an asbestos review, wetlands study and flood plain review. I’ve encountered situations where minor dumping of non-regulated liquids from 50+ years ago still show up in soil samples today and delay (if not kill) the deals due to investigations and clean up required by a lender.
  • MEP—Conduct, or have an expert conduct, a review of the mechanical, electrical and plumbing (sewer) of the property.
  • Building Structure—Inspect the building structure. Will the roof need replacing in the near future? Does it currently leak? How about the foundation? Is the building in code compliance?
  • Safety—Review for safety issues that will need to be addressed. If the property is industrial, what about OSHA compliance?
  • Warranties—Depending on what equipment is included in the sale and the age of such equipment, a review of warranties may be warranted to ensure they can be transferred to the new owner.
  • Liens—If title work was ordered, then any liens encumbering the property will be disclosed in the title report. Otherwise, a lien search should be conducted.
  • Compliance with local building/zoning laws—If an ALTA survey was conducted, then legal requirements regarding number of stories, parking, setbacks, etc. are identified on the survey. Otherwise, a buyer needs to investigate these items. A zoning letter is often required by the lender as well.

 

The list above doesn’t cover the economic review that would be required if the acquisition involves a going concern, such as an office building or multi-family apartments. That may be the subject of another post.

 

Property buyers should take care not to be penny-wise and pound-foolish. A little more time and expense up front can often save a lot more time and larger expense later.

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Monday, July 21, 2014

Divide and Conquer: How Repair Regs Impact Your Property

Reprinted/posted with permission of Cohen & Company, Ltd. Original copyright “Taxonomics”, Spring, 2014

Just when you think you’ve figured out the rules of the game…

The IRS has adopted new regulations for business deductions on tangible property. It’s a sweeping
category covering everything from the purchase of computers to the repair and maintenance of buildings.

The process for adopting the new regulations was arduous, consisting of 10 years of hearings and public comments before final adoption this past September. As a result, the new regulations are complex. However, taxpayers may need to take a close look and assess the new rules to determine the potential impact.

The Parts are More than the Sum
While known in the industry as “repair regulations,” Cohen & Company Tax Partner Angelina Milo says, “these regulations really apply to the acquisition, production and improvement of tangible property.” Milo adds that although the regulations will impact all industries, they are significant to the real estate industry and to those who own real estate.

Prior to the new regulations, if your company owned a building and made substantial repairs or replaced parts of the facility, the decision to capitalize or deduct the cost was made primarily by comparing the cost of the improvements to that of the entire building. Other factors also came into play, such as the expected life of the property, overall value of the improvement, etc.

While other factors are still part of the equation under the new rules, the biggest change is that a building is no longer considered one unit of property, but is instead subdivided into separate “units of property.” Therefore, when a repair occurs, the cost of the improvement must be compared as it relates to the specific unit to which it belongs. The regulations identify nine building systems, each
as a separate unit of property: HVAC, plumbing, electrical, escalators, elevators, security systems, fire protection and alarms, gas systems and other structural components.

For example, a company owns an office building with a HVAC system that consists of 10 roof-mounted units. The company pays $75,000 for labor and materials to repair those units. The HVAC system, including the roof-mounted units and their components, comprise a unit of property under the new repair regulations. If the $75,000 in work done on the roof-mounted units is considered a significant improvement to the HVAC system, the $75,000 repair is treated as an improvement that should be capitalized. Whereas before these new regulations, the $75,000 compared to the cost of the entire building may have been insignificant enough to merely deduct the expense in the same year.

Safe Harbor Options
The regulations provide for a routine maintenance safe harbor, which looks at the frequency of the repair and maintenance. For a building, if the taxpayer reasonably expects to perform routine maintenance on a unit of property at least twice within 10 years, then the costs may be expensed. Milo says, additionally, taxpayers may now deduct the cost of acquiring an item under another new safe harbor provision; this safe harbor allows a taxpayer, with an applicable financial statement, to expense items costing $5,000 or less per invoice or item. (An applicable financial statement is one that is required to be filed with the SEC, is a certified audited financial statement that is accompanied by the report of an independent CPA, or is required to be provided to a federal or state government or agency other than the SEC or the IRS.)

The expense threshold changes to $500 per invoice or item for taxpayers without an applicable financial statement. So, if the cost to acquire a new HVAC unit was $5,000, then the cost could be expensed. Although unlikely for the purchase of HVAC units, this provision may be very helpful for less expensive items purchased.

Milo says to take advantage of the safe harbor provision for acquisitions, the taxpayer must have a written financial policy at the beginning of the tax year and must make an election with the taxpayer’s timely filed tax return. In addition, taxpayers may choose to have capitalization policies in place in excess of the safe harbor amounts. However, should the return be audited, the taxpayer will have to show that the amount in excess of the safe harbor is appropriate and clearly reflects income.

Out With the Old
In conjunction with the final repair regulations, regulations have also been proposed regarding the disposal of tangible property. Under the proposed rules, a taxpayer may elect to recognize a loss upon a partial disposition of tangible property. For example if the taxpayer replaced five of the 10 mounted HVAC units, a taxpayer will no longer need to dispose of an entire building to recognize a loss. The taxpayer would capitalize the costs of the new units while electing to deduct the remaining costs of the units replaced.

Looking Ahead
While compliance with repair regulations will be mandatory on 2014 returns, which by then could also include final regulations regarding the disposition of property, taxpayers have the option to voluntarily comply with both the repair and disposition regulations on their 2013 tax returns.

“Considering the expansive nature of these regulations, we have been meeting with clients so they understand the technical and practical application,” says Milo. “The ultimate impact will vary depending on each taxpayer’s existing policies and procedures.”

Ranked one of the top five accounting firms in northeast Ohio and top 100 nationally, Cohen and Company is a full service accounting firm with the following specialties: tax planning and compliance; accounting/auditing; business consulting; wealth management; transaction and litigation services; and corporate finance.

Angelina Milo, the author of this article is a partner with the firm, specializing in tax planning and general business consulting for individuals and closely held businesses. She is also experienced in assisting businesses through acquisitions, divestitures and succession planning. You can contact Angelina Milo of Cohen & Company for more information at amilo@cohencpa.com.



Monday, July 14, 2014

Owning Real Property as Tenants in Common


Owners of commercial property have increasing found benefit in owning their separate interests in the property as “tenants in common.”  Typically, if two or more parties wanted to jointly own a commercial property, the typical approach would be to form a limited liability company (LLC) to hold title to the property and the ownership interests of the LLC would be held in varying percentages by the parties. Most of the time, this will remain the preferred approach.


However, when one or more of the parties wants to use funds held in a 1031 exchange for the property purchase, holding title to the property as a tenants-in-common interest (TIC Interest) is a better option.


A TIC Interest is an undivided interest in the real property, which can be bought or sold separately from the other undivided interests in the property and can be separately mortgaged. 1031 exchange funds can be used to purchase a TIC Interest, but cannot be used to buy a partner’s equity interest in an LLC.


The parties that collectively own the TIC Interests a property will enter into a Tenants in Common Agreement (TIC Agreement) which sets out the terms and conditions upon which each will hold their respective TIC Interests and specifically elects to be excluded as a partnership under the Internal Revenue Code.


The TIC Agreement, will address property management, how income, expenses and liabilities of the property will be handled, and remedies that will be taken if a tenant in common doesn’t pay his or her proportional share of property expenses, and also identify other tenant in common obligations, such as compliance with loan obligations that affect the property as a whole.


If the property as a whole will be mortgaged, the lender may require additional provisions be added to the TIC Agreement for so long as the loan is outstanding, particularly if the loan will be a CMBS loan.


While TIC Agreements do not have to be lengthy or complicated, it is critical that the parties enter into such an agreement while the interests are held as TIC interests.  If even one of the tenants in common fails to cooperate or pay proportional expenses, then the other TIC owners need the ability to take action against the other owner.

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Monday, July 7, 2014

How to Spell Real Estate Tax Relief in Ohio-“ESOP”, “PTAP” “TOP”…

While paying taxes is still one of the “top 2 certainties” in our lives, and we can’t legally avoid them, there are a number of property tax deferral/loan/grant programs currently in place (or in process) in Ohio offering some relief.

Most counties in Ohio allow taxpayers to pay in installments.

In Cuyahoga County, the “EasyPay” program allows current taxpayers (or those on delinquent tax payment plans) to have their upcoming real estate tax payments automatically deducted from their checking or savings account:

 (i) Monthly - 1/6th of the taxpayer’s estimated future tax bill will be withdrawn from their account around the 5th of each month.  Each January and July the remaining balance due for the period will be withdrawn from their account on the last day of the collection period;

(ii) Semi-Annually - Withdrawals will occur twice a year on the last day of each collection period in January and July.  The taxpayer may elect to have the first payment made on the last business day of December instead of the collection closing date; or

(iii) Annually – The taxpayer’s full year tax amount will be withdrawn either on the last business day in December or the last day of the January tax collection.

Call (216) 443-7420 or log on to: http://treasurer.cuyahogacounty.us/en-US/easypay-plans.aspx  
for more information.

In Franklin County, the Budget Payment Program allows taxpayers to make monthly prepayments on their semi-annual tax bill. The money paid will be held in an escrow account in the taxpayers name and will automatically be applied to their semi-annual real estate tax bill when it comes due. Payments can be made by personal check, certified check, money order, cash, credit card, or direct debit.
By choosing the monthly direct debit from your checking or saving account the taxpayer can receive an interest credit towards future taxes.
  • The interest earned on the taxpayer’s escrow account is paid at the same rate of return as the Treasurer's investment portfolio.
  • Interest is calculated on all of the taxpayer’s monthly payments from their first direct debit until the tax due date.
  • The interest is credited to the taxpayer’s escrow account, which goes toward their taxes for the next billing cycle.
Should you have questions or require additional information please e-mail the Treasurer, call the Franklin County Budget Payment Unit at 614-525-3438 or log on to: https://treasurer.franklincountyohio.gov/payments/budget-pay

In Hamilton County, the Treasurer's Optional Payment (Top) Program allows
 residential and commercial  property owners to prepay their real estate taxes in five installments.
 It is similar to an escrow account with a financial institution. There is no service charge associated with the program.

  If interested in the “TOP Program”: Taxes must be current;  both residential and commercial properties qualify; and the Top Program cannot be used to pay taxes already owed.

 Once enrolled in the program, the taxpayer will be sent four prepayment coupons, representing their estimated tax payment. Each month they would mail their one-fifth payment, along with a coupon, to the treasurer's office.  The final statement will be the taxpayer’s tax bill, which will reflect all prepayments made and the final balance due.

 If you would like more information about this program, please call: 513/946-4788 or log on to: http://www.hamilton-co.org/treasurer/TOP2.html

Franklin County has a one-time emergency grant program-“PTAP”
.
The Senior Citizen Property Tax Assistance Program of Franklin County (PTAP) is a not-for-profit organization with an endowment fund through the Columbus Foundation which has as its purpose, the collection and distribution of funds to assist needy senior citizens and disabled individuals in the payment of their property taxes. These funds are to be provided for tax payments on an emergency basis only. The program is to assist eligible 60 plus year old senior citizens or disabled homeowners on a one-time basis (However, if applicant has a history of property tax delinquency, assistance will be determined on a case-by-case basis).

Income eligibility is to be based on 150% of the Federal Basic Needs Standard.  "Disabled" is defined as a person who is unable to engage in any substantial gainful employment or activity because of a physical or mental impairment that is expected to last for an extended period of time. The applicant should be receiving or has applied for disability payments such as SSI, SSD, VA etc.

If you would like more information about this program, log on to: https://treasurer.franklincountyohio.gov/tax-savings/property-tax-assistance-program

In Cuyahoga County, “ESOP” is about to unroll (August/September, 2014) its delinquent  property tax loan program

As reported by Sheryl Harris, Consumer Columnist with the Cleveland Plain Dealer in her article “ESOP Offers Loans to Seniors who Fall Behind on Property Taxes: Plain Dealing”, posted on June 27, 2014 (on Cleveland.com), eligible Cuyahoga County residents will soon be able to apply for loans to pay off their delinquent tax bills. According to Ms. Harris, “Sometime late this summer, Faith Community United Credit Union, which is administering the loans, will be taking applications from Cuyahoga County residents 55 and older [for 3 year, 10% loans]”. “ESOP refined the idea for the tax loan program with the help of the Clinton Global Initiative. Third Federal kicked in the $200,000 needed to cover the initial loans and associated costs.”

For the complete article by Ms. Harris, log on to: www.cleveland.com/consumeraffairs.com. Ms. Harris can be contacted at: 216-316-6832 (c) or sharris@plaind.com.

For additional information about the Senior Tax Delinquency Loan Program or ESOP's programs for homeowners, contact ESOP through www.esop-cleveland.org or call: 216-361-0718.



Monday, June 30, 2014

When Entering Into Litigation Affecting Real Property, Done Limit Your Options


A case decided in July last year, 2115-2121 Ontario Bldg., L.L.C. v. Anter, 2013 Ohio 2995 (8th Dist. Ct. of App., Cuyahoga Cty.) illustrates perfectly the need to not limit your options when initiating litigation, and the need to remain consistent with the path you do elect to follow.

 

Certain property in downtown Cleveland known as the Stanley Block building was in incredible disrepair and subject to an order by the City of Cleveland that the building was a public nuisance and all building violations had to be cured or the building would be demolished. There was a deadlock among the owners of the building, with 2115-2121 Ontario Bldg., L.L.C. (the “Plaintiff”) owning 50% of the entity owning the property and the remaining 50% held by several other individuals. The Plaintiff filed a complaint against the company Macron Investment Company, the building owner (“Macron”), and the other equity owners of Macron. The Company was limited to the following 3 issues: requesting (i) a declaratory judgment that the Plaintiff was a 50% owner of Macron, (ii) injunctive relief and an order transferring certain equity to the Plaintiff and (iii) an accounting of rents and income related to the building.  The Plaintiff won but the order was promptly appealed by the others.

 

While the appeal was pending, the fines assessed by the City of Cleveland were steadily racking up.  The Plaintiff filed a motion with the court asking for a receiver to be appointed to take control of the building and proceed with its demolition.  After conducting the appropriate hearing, the court appointed a receiver. The defendants in the litigation appealed, challenging the appointment of a receiver and asserting that the powers granted to the receiver exceeded the underlying action (i.e., the complaint filed by the Plaintiff). Since no stay was requested nor granted when the defendants appealed, the appellate court upheld the appointment of a receiver. However, the complaint originally filed by the Plaintiff was for limited purposes related to ownership of Macron and obtaining an accounting of the building rents and income. The complaint did request any action related to preservation of the property or other related actions.  

 

The appellate court agreed with the defendants and found that the authority granted to the receiver went beyond the scope of enforcing the lower court’s judgment.

 

When dealing with complicated disputes, it is often a chess game and parties need to think several steps ahead.  Because the Plaintiff filed a complaint with a very narrow scope, when the litigation process dragged on (as litigation typically does) and the building situation kept deteriorating, the Plaintiff was painted into a corner without any decent options. Seeking the appointment of a receiver was a great next step, but any motion for such an appointment needs to be consistent with the underlying complaint (and if a judgment has been rendered, with the judgment).  In a dispute, if there is any realistic potential need for a receiver to step in a stop further damage to property, then take care to file a complaint that is broad enough to allow the receive to do so.

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Monday, June 23, 2014

Tree (or House) falls on Motorist (or Witch); Act of God or Negligence?

In the Land of Oz, the issue was clear. “The house began to pitch. The kitchen took a slitch. It landed on the Wicked Witch in the middle of a ditch.” No negligence or other fault on the part of Dorothy.  In the case of falling trees in the land of Ohio, the issue is not so clear. The relatively recent case of Kish v. Scrocco, 2013-Ohio-899 (7th Dist. Ct. of App., Mahoning Cty.), however sheds a little light on the subject.

As the court in Kish recognized, falling tree cases are often “sad and tragic”. We agree and our sympathies go out to the Kish family.

The facts of the case are relatively simple. On April 16, 2007, Lawrence Kish was driving on Shields Road in Mahoning County when a tree on the Scroccos’ property fell onto Kish’s vehicle and killed him. A bad storm blew the tree over, but the tree was later found to have been significantly diseased and partially hollowed-out.  The Kish Estate filed a wrongful death claim, claiming negligence on the part of the Scroccos for failure to cut down the tree when it became diseased. The trial court granted (summary) judgment for the Scroccos. The 7th District Court of Appeals affirmed the trial court’s decision.

In analyzing the case, the court of appeals first summarized the common law requirements to establish negligence. To sustain a claim of negligence, Kish would need to show: a duty owed by the defendants to the deceased, a breach of that duty, injury or damages, and the existence of proximate cause between the breach and the injury or damages. A full analysis of all of the factors was not necessary, however, as the court found there was no duty owed by the defendants to the deceased.

Using prior case law as precedent, the court reasoned that the Scroccos would have a duty if they had actual or constructive knowledge of the diseased condition of the tree that fell and killed Kish. However, if there is no knowledge of the tree’s condition, either actual or constructive, then the landowner would not be liable.
 The Kish Estate claimed the Scroccos had constructive knowledge (that they should have known) of the diseased condition because an examination of the tree after its fall showed loose and missing bark, no leaves, and the lack of structural integrity to the inside of the tree. Mrs. Scrocco had testified that she was a frequent visitor to her property, but the tree did not exhibit any signs of disease or decay until after it fell. She further
stated that the tree did not have any leaves on it before it fell because it was too
early in the year and that other neighborhood trees did not have any leaves at
that time. Experts at trial bolstered the Scrocco’s claims. While reports did show a lack of structural integrity inside the tree, i.e. it was hollow; the experts could not confirm that such evidence was visible from the outside of the tree before it fell.

The appellate court contrasted the facts of the Kish case with that of Levive v. Brown, an 8th District Court of Appeals case. In Levine, the tree that fell was riddled with termite holes, with no live branches, bark, or green leaves. Additionally, evidence presented in that case demonstrated that the tree that caused damage (to the Levine’s property) had been dead for at least a year, that it was easily visible, and that the Browns (defendants) had a history of refusing to remove trees and trim branches on their property that Levine felt may be a danger to his property.

The Scroccos also argued that the falling of the tree was an “Act of God”, and accordingly, they should not be liable for same. The court recognized the “Act of God Defense” and cited previous authority holding that if an Act of God is “so unusual and overwhelming as to do damage by its own power, without reference to and independent of any negligence by defendant, there is no liability”.  An Act of God has been defined by Ohio courts as: “any irresistible disaster, the result of natural causes, such as earthquakes, violent storms, lightening and unprecedented floods. It is such a disaster arising from such causes, and which could not have been reasonably anticipated, guarded against or resisted. It must be due directly and exclusively to such a natural cause without human intervention”.

The court in Kish, noted, however that it did not need to apply the “Act of God defense” in its case, because the court had already concluded that there was no negligence because there was no duty (because there was no actual or constructive knowledge of the tree’s diseased condition).

The moral of this story is don’t wait for your municipality, the electric company or a court action to examine and remove dead or diseased trees on your property. If you know or should know of a problem, the cost to remove same, sooner, will always be cheaper than the potentially costly and sometimes deadly consequences, later.

If the evidence showed Dorothy’s house was more susceptible to “twitch” because she used substandard construction materials, there would have been a completely different ending.

Monday, June 16, 2014

Selling Commercial Real Property “AS-IS” Is Not a "Get Out of Jail Free" Card


It’s not uncommon for property owners today to want to sell their real property ‘as-is” and not remain on the hook for problems that arise later. However, there are limits to what an “as-is” clause covers.
 
“As-is” clauses refer to the physical condition of the property and relieve the seller of a duty to disclose any defect in the physical condition of the property. Including an “as-is” clause does not protect a seller from claims based on fraudulent misrepresentation or fraudulent concealment. This does not mean than a buyer who gets burned on an “as-is” purchase can merely cry fraud and have his or her day in court. Nondisclosure does not equal fraud when the sale is an arm’s length commercial real estate sale and the seller has no fiduciary or other special duty that might otherwise require him or her to speak out about undisclosed conditions. There may arise, however, unique situations where the facts of the case indicate that the seller’s actions go beyond mere nondisclosure and justifies further fact finding by the court. That is exactly what happened in the following case in Washington County, Ohio.
 
In Mar Jul, LLC v. Hurst, 2013 Ohio 479 (4th Dist. Ct. of App., Washington Cty.), Mar Jul purchased a commercial building with tenants from Hurst and the contract contained an “as-is” clause regarding the condition of the property. After the closing the buyer found several problems with the property, including insufficient water supply, the building being out of square and sinking, and materially inaccurate lease information.  Mar Jul sued Hurst alleging fraud, and related causes of action. The trial court granted summary judgment in favor of the seller based on the “as-is” clause in the purchase agreement.
 
Mar Jul appealed and the appellate court reinstated a portion of the case. The trial court’s dismissal of claims related to the physical condition of the property was upheld, but the appellate court found that Mar Jul did not have adequate opportunity to obtain the lease information regarding the building tenants and its reliance on the seller, Hurst’s, representations in the purchase agreement regarding the lease terms was not unreasonable. The court felt there were sufficient questions of fact that warranted allowing the Mar Jul its day in court to present its fraud claims regarding the leases.
 
When buyers of commercial real property are considering an “as-is” purchase, they need to negotiate adequate time for thorough due diligence prior to any closing or risk suffering substantial financial consequences. A thorough inspection of the premises and review of the leases is time and money well spent. If a seller doesn’t want to cooperate and allow for adequate inspection and review, then walk (or even run) away. Sometimes no deal is better than a bad one.
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