Real Estate Risk Management Roundup
Don’t make these same mistakes.
You can never have too much safety. When you work a real estate deal, you might even check the fine details ten times to make sure everything aligns.
Dive into the following case studies to add an extra layer of protection to your real estate career.
Case Study 1: Agent Sued for Failure to Coordinate Tax Benefits
A real estate agent assisted a client with the purchase and sale of various properties as they upgraded from one property to the next. Typically, when you sell property and have a gain, you must pay tax on the gain at the time of the sale. However, under Section 1031 of the IRS Code, you can postpone paying tax on the gain if you reinvest the proceeds in a similar property as part of a qualifying like-kind exchange.
The agent advised the client to pursue a 1031 transaction due to the tax benefits. The client agreed, and the agent offered to coordinate the transaction. A property was purchased with the understanding that the Section 1031 tax benefit would apply.
The 1031 like-kind exchange documents were inadvertently omitted from the contract documents of the property being sold and the newly purchased property. Due to the oversight, the proceeds from the sale of the existing property were not placed into escrow with a qualified intermediary, and the tax benefits were lost. The client was responsible for paying a 15% federal capital gains tax and an 8% state capital gains tax.
The agent did not refer his client to a tax or legal expert. He also neglected to include the 1031 like-kind exchange documents in the contracts for both the sale and purchase of the properties. Moreover, the agent failed to read the closing documents and attend either closing, losing a final opportunity to discover the problem.
The client sued the agent for failing to include the 1031 like-kind exchange documents in the closings of both properties. The agent acknowledged his mistake, and the claim was settled for more than $50,000 shortly after the suit was filed.
The agent should have referred his client to a tax advisor and/or attorney instead of offering to coordinate the transaction. In addition, the agent should have reviewed the closing documents to assure complete compliance with prior agreements and representations. Had the agent done so, he would have realized the 1031 like-kind exchange documents were missing.
The agent could have also created a checklist to confirm all requirements for both transactions were satisfied. Finally, attending the closings would have provided a last line of defense in the effort to assure the transactional paperwork was complete.
Case Study 2: Condo Owner Sues Property Manager for Nuisance
A licensed real estate agent entered into contract with a Condominium Owners’ Association (COA) to serve as property manager for a condominium complex. The owner of a condo unit made numerous complaints to the agent regarding the heavy cigarette smoking by residents of the unit below that aggravated her asthma and made her unit dangerous and unhealthy.
The agent presented the complaints to the COA board. The applicable condominium rules and regulations prohibited owners from any act which would “unreasonably interfere with the rights, comforts, or conveniences of other owners or residents.” Nevertheless, the board declined to take any action to sanction the owners of the unit below in response to the complaints.
The owner filed suit against the owners of the unit, the COA, and the agent, alleging claims for failure to abate a private nuisance and breach of contract. The owner sought damages in the amount of $4 million.
The court granted demurrers (motions to dismiss) filed on behalf of the COA and agent.
The court agreed with these defendants that the plaintiffs had failed to plead facts showing that either had used, owned, or had control of the unit where the alleged offensive activity was occurring. The court also ruled that the COA’s rules and regulations did not constitute a contract between the plaintiff and any of the defendants.
However, the court overruled the demurrer of the owners of the condo unit below based on legal authority that a claim for private nuisance may be stated, even though an offending condition may be caused by a lawful act.
The court’s ruling in favor of the COA and its agent is generally in accord with decisions of courts in New York, Maryland, and Alaska dismissing claims for private nuisance based on secondhand smoke in a multi-dwelling property.
However, a California court has held that a claim for private nuisance was adequately pled based on a landlord’s failure to restrict secondhand smoke in common areas. At least one state, Utah, has statutorily declared secondhand smoke in multi-party dwellings to be a nuisance.
Agents should be informed as to the applicable laws, rules, and regulations governing smoking in multi-dwelling properties in both common areas and individual units. They should consider their duties to disclose the potential application of such laws to client owners/landlords, prospective buyers, and tenants of such properties as a material fact related to the property.
Case Study 3: A Violation of the Real Estate Settlement Procedures Act
A mortgage brokerage firm had an arrangement with a lender who paid the firm based on the number of referrals received. The brokerage firm required clients to obtain a mortgage pre-approval from this specific lender, even if the client had already received pre-approval from another lender.
According to the Consumer Financial Protection Bureau (CFPB), this is a violation of the Real Estate Settlement Procedures Act (RESPA). RESPA prohibits real estate agents and brokerage firms from recommending settlement services, such as title insurance, appraisals, inspections, and loan origination to consumers in exchange for payment from service providers. This activity is known as an illegal kickback scheme.
The brokerage firm should have known that it is illegal to make or accept payments for mortgage referrals.
The lender and brokerage company were ordered by the CFPB to pay civil penalties and consumer compensation.
Never make or accept payments for referrals, because it is illegal. To ensure you are always working within the law, familiarize yourself with RESPA and keep up to date on additions and/or amendments to the law.
It should be noted that fines, penalties, and sanctions are not covered by errors and omissions policies. Review your policy to make sure you have proper coverage in place for your business.
This article was produced in conjunction with XL Catlin and is not to be taken as legal advice.