The 1031 Exchange and Real Estate

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For real estate investors, the 1031 exchange is a powerful tool for managing tax liability when selling and purchasing investment properties.

Normally, when property is sold, any gain on the sale will be taxed.  However, the 1031 exchange allows an investor to defer capital gains tax on the sale of a business or investment asset when the investor uses the proceeds to purchase an asset of like-kind. This is extremely beneficial to investors as it provides them with more capital to invest in their subsequent purchase.  Although the 1031 exchange can be used in a variety of different ways, it is most commonly associated with real estate transactions.

In order to engage in a 1031 exchange, the property must be a business or investment asset, meaning the property generates revenue or helps in generating revenue.  Typically, these properties will be warehouses, offices or rental homes.  Primary residences and other property that do not generate regular income do not qualify, such as a second home or vacation home.   Further, the property exchanged must be of like-kind, meaning that the swapped properties are of a similar nature.  With real estate transactions, like-kind is interpreted liberally as most real estate will be like-kind to other real estate.  For instance, real property with a structure on it will generally be considered like-kind to vacant land and vice-versa.

The timing of a 1031 exchange is extremely important.  First, the investor needs to hire a qualified intermediary before they close on their sale because the funds cannot be held by the investor and must be held in a trust for the subsequent purchase. Most often, the qualified intermediary will be a bank, title company or attorney.  Second, the investor must identify in writing a designated replacement property within 45 days of the closing on the sale.  Generally, an investor may identify up to three properties that may serve as the replacement property, and at least one of these properties must eventually be acquired as the replacement property.  In some instances, an investor can identify more than three replacement properties so long as either (i) the fair market value of all the identified replacement properties does not exceed 200% of the value of the sold property or (ii) the investor purchases at least 95% of all identified replacement properties.  Third, the investor must close on the designated replacement property within 180 days of the closing on the sold property. For this reason, it is recommended that an investor that wants to engage in a 1031 exchange be in contract for the purchase of the replacement property near the time of closing on the sold property.

It should be noted that if there are any gains realized in the exchange, the gains will be taxed.  For example, if the sale proceeds on the sold property are greater than the cost of the replacement property, then the investor will be taxed on the difference.  Further, where the properties are financed, if an investor’s mortgage liability is reduced by the exchange, this would also be considered a gain and thus taxed.  Alternatively, if there is a loss in the exchange, an investor can choose to defer the loss under the 1031 regime, although this is in most instances unadvisable.

For owners of business or investment property, the 1031 exchange provides an amazing opportunity to upgrade assets with minimal tax consequences.  Although a 1031 exchange does require planning and adherence to a strict protocol, it should always be considered when an investor or business is looking to simultaneously buy and sell assets.

For more information on 1031 exchanges or real estate law generally, please contact the NYC real estate attorneys at the Kanen Law Firm.

Kanen Law Firm | Manhattan Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

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What are lot line windows?

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New York City real estate has a lot of intricacies and quirks, but one of the more important ones that purchasers need to be aware of are lot line windows.  Lot line windows are windows located directly on edge of the building’s property line.  These windows are common in New York City where space is scarce and developers try to maximize square footage.  Lot line windows can be a headache because they can devalue a property and need to adhere to strict guidelines.

Whenever a wall of a building is flush against the property line, the windows on that wall will most likely be deemed lot line windows by the Department of Buildings.  If the adjacent property ever builds up to the height of the window, the window must be permanently boarded up, usually at the owner’s expense.

Lot line windows can prevent a room in a property from being deemed a legal bedroom.  In NYC, to be characterized as a bedroom, the room needs a window that provides a certain amount of natural light.   Lot line windows cannot satisfy this requirement because theoretically they may have to be closed up, depriving the room of the required natural light. If a room has only lot line windows, this room is not a legal bedroom.  A property with this type of room cannot advertise the property as if the room was a bedroom.  Often, listings will refer to a room with only lot line windows as a ‘home office’.

Additionally, if a lot line window has not yet been required to be boarded up, it must meet certain specifications to protect from fires spreading to and from the building.  Among the requirements, the window must be made of a fire-rated glass, which is more expensive than normal glass.  Also, in some instances, a sprinkler will need to be strategically placed by the window.

If you are concerned that a property you are interested in may have lot line windows or have any other questions about real estate law, please contact the New York City real estate attorneys at the Kanen Law Firm.

Kanen Law Firm | Manhattan Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

What’s up with New York’s Mansion Tax?

What's Up

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The “Mansion Tax” is a New York State tax imposed on the purchase of residential property for $1 million or more, excluding the sale of personal property and most closing costs. The tax requires the purchaser of the property to pay 1% of the purchase price to the state.  This tax applies to transactions for individual condos and co-ops as well as one to three family homes.

Governor Mario Cuomo enacted the mansion tax in 1989 as a luxury tax to increase state revenue.  The tax has survived to this day completely unchanged or updated.  In recent years, many have criticized the $1 million threshold as out-of-date and an imposition on the middle class, citing that $1 million in 1989 represents approximately $1,877,000 today adjusted according to the Consumer Price Index.  Confronting this issue, a few NYS lawmakers have proposed bills to push the threshold from $1 million to $2 million, but the passage of these bills is currently uncertain.

Purchasers of new developments should be careful when considering the implications of a mansion tax.  If a purchaser is required to pay city transfer taxes, then the transfer taxes will be considered part of the purchase price for the purposes of the mansion tax.  Generally, transfer taxes are paid by the seller, but in transactions for new developments, sponsors usually shift the transfer taxes to the purchasers.  For transactions over $500,000, the transfer tax is around 1.425% of the purchase price.  Thus, to avoid the mansion tax for new developments, the purchase price should be under approximately $980,000.

As with almost any tax, people have attempted various methods to circumvent or minimize the mansion tax.  One of the more prevalent strategies is for the purchaser to contract with the seller to share the burden of the mansion tax.  This strategy is completely legal, however, sellers rarely have incentive to consent as their share of the mansion tax would not reduce any capital gains or transfer tax.  Another strategy has been to increase the amount of personal property being purchased in the transaction in order to decrease the purchase price of the real estate.  The purchase of personal property is not included in the purchase price for mansion tax purposes, but redistributing costs to avoid the mansion tax is highly problematic and not advisable.  Aside from a potential IRS audit and a tax fraud conviction, any portion of the sale relating to personal property would still require sales tax to be paid.

There are a few silver linings to the mansion tax though. A purchaser can eventually deduct the mansion tax from any capital gains resulting from a subsequent sale, similar to the way capital improvements can be deducted.  Further, the mansion tax will usually not apply to the transfer of the real estate by gift, devise, bequest, inheritance or transfer by will.

In sum, the mansion tax is something purchasers should keep in mind when looking at properties priced at $1 million or more.  Purchasers looking at new development properties should also be aware that the city’s transfer taxes will be included in their purchase price.  There may be some relief from the mansion tax in the near feature if lawmakers are able to raise the threshold to $2 million.  Regardless, prospective purchasers should consult with their attorney to understand the implications of the mansion tax on their potential real estate purchases.

For further information please reach out to the Manhattan real estate attorneys at the Kanen Law Firm, or call us at 212.922.9099.

Kanen Law Firm | Manhattan Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

Trends in Mortgage Contingency Clauses

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Most people looking to purchase a new house or apartment will need financing.  This is the reality for most that make a foray into the real estate world.  However, sellers hate financing because it could be a major stumbling block for the deal.  In most real estate contracts that involve financing, the purchaser is given a mortgage contingency that provides the purchaser with a refund of the contract deposit if the purchaser cannot obtaining financing after a good faith effort.  Mortgage contingencies can be extremely frustrating to sellers as they provide a means for purchasers to escape purchase contracts, temporarily take the property off the market and provide no compensation to the seller for the lost time.

With the New York City real estate market seeing extreme demand pressure, sellers have been using this leverage to employ new tactics to diminish the protections provided to purchasers in mortgage contingency clauses.

Mortgage Contingency Clauses that require application to a lender of the Seller’s choice.

Purchasers can sometimes escape purchase contracts by going to a lender that refuses to make a loan because it disapproves of the property.  Sellers have begun to combat this tactic by including a clause in the purchase contract requiring purchasers to go to a lender that has already pre-approved the building.

When a lender evaluates a mortgage application, the lender will look at both the borrower and the property.  The lender may find that the purchaser is credit worthy but determine that the property does not fit its criteria for a mortgage loan, and thus reject the mortgage application.

A property can be rejected by a mortgage lender for a variety of reasons, and rejection does not necessarily mean that the property is a poor investment.  For instance, Fannie Mae lenders have very strict guidelines as to which properties it will approve for mortgages.  With apartment sales, Fannie Mae will not approve buildings that have one entity owning more than 10% of the units or have commercial space that comprises greater than 20% of the building.  Although these requirements are in place to ensure safe lending practices, many NYC apartments will not meet Fannie Mae’s lending criteria but still be great investments.

Purchasers that have buyer’s remorse will sometimes go to a strict lender in order to get rejected for a mortgage and renege on a purchase contract.  However, now that sellers have greater leverage, they have been able to negotiate a caveat into mortgage contingency clauses that require the buyer to go to a lender that has already pre-approved the property.  As long as the purchasers is credit worthy, this caveat prevents purchasers from being able to slip the purchase contract by going to an overly strict lender that rejects the property.  It should be noted that the purchaser can still use a lender of their choosing, but if they are unable to find one, they will have to end up using the lender chosen by the seller.

This caveat in mortgage contingency clauses are great for the seller because it protects them from purchasers unfairly jumping ship.  It should also be noted that its not necessarily a bad deal for purchasers either as having a lender in place that has already pre-approved the building can save a purchaser time in finding a lender.

Some purchase contracts have done away with mortgage contingency clauses all together.

Another practice that has become more prevalent with increased sellers’ leverage is the exclusion of mortgage contingency clauses from purchase contracts all together.  Generally, sellers prefer all cash deals, but removing the mortgage contingency provides sellers with the next best alternative.  By removing the mortgage contingency from a purchase contract, sellers are able to retain a purchaser’s contract deposit if the purchaser is rejected for financing.

Entering a purchase contract without a mortgage contingency can be dangerous for purchasers.  The mortgage contingency clause is there to protect purchasers in the event the purchaser’s lender refuses to facilitate the transaction.  As discussed above, lenders primarily reject purchasers based on either the purchaser’s creditworthiness or the building’s financial condition.  In most real estate transactions, lenders typically don’t do an in-depth analysis of the building’s financials till after the contract is entered into.  This leaves purchasers that have no mortgage contingency in a precarious position. The purchaser’s credit may be good, but the lender can still reject the transaction because it disapproves of the building’s finances.

There are ways for purchasers to protect themselves in situations where they must enter a contract without a mortgage contingency clause.  The purchaser should go to his or her lender before entering the contract and see if the building is already pre-approved or if the lender can check if the building is approvable.  Most lenders will do this for customers as a courtesy.

Although entering a contract without a mortgage contingency clause can be risky, it may be the only way to get your ideal property.  Before doing so, you should consult with your lender and attorney to make sure it’s the right situation for you.

If you ever find yourself with a question about mortgage contingency clauses or real estate law generally, please feel free to contact the NYC real estate attorneys at the Kanen Law Firm.

Kanen Law Firm | New York Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

Considerations for Purchasers of New Construction Projects in New York

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There are several major distinctions associated with real estate contracts for newly constructed homes in New York. The two major distinctions are the additional fees paid by the purchaser and the implied warranties covering the nature of the construction. These distinctions are customary in New York and should be carefully considered when deciding whether purchasing a newly constructed home is right for you.

Hidden Fees

When purchasing a new construction home in New York, a major factor to consider is that the Seller will likely try to shift the burden of ancillary costs to the Purchaser. There are usually clauses in the purchase Contract which result in the Purchaser being responsible for certain costs and fees that are customarily covered by the Seller in transactions for older homes. Common examples of these additional fees include requiring the Purchaser to purchase a survey through the Seller’s surveyor, transfer taxes, Seller’s legal fee, and administrative fees. These clauses may or may not be negotiable depending on the Seller. The purpose of these hidden fees is to recoup some of the costs associated with the project and to increase revenue. By incorporating extra costs into the Contract, the Seller is also able to list the property for a lower asking price making the unit more appealing to potential buyers.

It is up to your attorney to spot these deviations and try to negotiate their removal. If these additions are not negotiable your attorney will need to make sure that each charge is adequately explained to you and that you understand the consequences.

A good real estate attorney will know exactly where these fees are located in your contract. He or she will easily be able to point out each fee and explain the implications associated with each one. A good Real Estate Attorney will also know the best way to negotiate their removal.

Additional Warranties

Aside from getting a brand new home, another major benefit of purchasing a new construction is the implied warranties that buyers receive. According to the New York General Business Law Article 36-B purchasers of single family homes or individual cooperative or condominium units in a structure of five stories or less receive special benefits. Those special benefits include special warranties that extend the liability of the builder beyond closing.

First, Purchasers will receive a one year warranty against the builder’s failure to construct the home in a skillful manner (GBL §777-A(1)(a)). This warranty includes defective workmanship, defective materials supplied to the builder, and defective design (provided the design was provided by a design professional retained exclusively by the builder). This ensures that the builder has completed all work in accordance with industry standards and used materials that are commonly accepted in the industry.

Second, Purchasers will receive a two year warranty that ensures the installation of plumbing, electrical, heating, cooling and ventilation systems of the home were completed without defects (GBL §777-A(1)(b)). The warranty covers any defect that occurs as a result of the builder not installing said systems in a skillful manner. It should be noted that this warranty does not cover the goods themselves. Rather, it covers the manner in which these goods were installed.

Third, Purchasers will receive a six year warranty which ensures that the home will be free from material defects (GBL §777-A(1)(c)). A material defect can be defined as a condition of the property that would have a significant adverse impact on the value of the real property. An example of a material defect would be a defect with the home’s foundation. This warranty covers major structural defects in the home and ensures that you are protected in the event that one of these major defects are discovered within the six years that the warranty is applicable.

As previously mentioned, these warranties do not extend to the goods sold incidental to the transaction (i.e. stove, refrigerators, freezer, air conditioners, etc…). Rather, GBL §777-A covers defects that may arise due to a builder’s failure to have installed the systems in a skillful manner. Defects with respect to the goods themselves are covered by article two of the uniform commercial code.

Conclusion

When considering the purchase of a newly constructed home remember that retaining the right attorney should be your paramount priority. You should ensure that your attorney has experience dealing with new construction contracts and that he or she is aware of all of the intricacies involved in the transaction.  An effective real estate attorney will ensure that your interests are protected from contract negotiation through your closing date.

If you have any questions about purchasing a new construction please feel free to contact our office and speak with one of our experienced real estate attorneys.

Kanen Law Firm | New York Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

Title Insurance 101

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“Title” represents the bundle of rights associated with property ownership. Whoever title is vested in has the right to possess, occupy, improve or transfer that property as he or she sees fit. If you are financing your purchase of real property in order to obtain title, your lender will likely require you to purchase title insurance.

What is Title Insurance?

Title insurance is indemnity insurance bought by the purchaser of real property which protects against future defects in title. A title insurance policy is a contract of indemnity which insures against an actual monetary loss because of a defect, lien or other matter affecting title. Unlike other forms of insurance that insure against future loss, title insurance protects the insured against defects in the title that exist at the time of the closing but are asserted at a later time.

Title insurance insures against the risk that defect(s) will interfere with the insured’s interest. For a lender, that interest will be the priority of its lien; for the owner, it is title to the property free from the claims of third parties that could divest the owner of title.

If a defect in title is found it, will be the Title Insurance Company’s job to protect you against outside claims. The Title Insurance Company will pay the costs, attorney’s fees and expenses incurred in the defense of your title. Any money paid by the company will NOT reduce the amount of your insurance.

When is a Title Defective?

There are often instances when individuals or entities come out of the woodwork following your closing and argue that they have rights in the real estate that you purchased. Common defects in title include fraud, human error, improper deeds, improper wills, liens against your property and claims to ownership. These are problems that are not discoverable in a routine title search. These problems occur more often than you would think, and if it ever happens to you, you don’t want to be caught without a title insurance policy.

Who is Covered by Title Insurance?

When you purchase a house, townhouse or condo in New York State, your lender will require you to buy title insurance on their behalf. This is called a “lender policy”. The lender policy that you will be required to purchase will cover the outstanding balance on the mortgage for the lender, but it will not protect you. Buyers are encouraged to purchase their own title insurance policy. This policy is called an “owners policy”. An owners policy will provide the maximum protection if there is ever a claim against your home.

The protection you purchase at closing will continue for as long as you own that property. Once you transfer or convey your interest in the property your policy will expire and the purchaser will be required to obtain a new policy.

How Much Does it Cost?

You purchase title insurance by paying a one-time premium at the closing of title. In New York State, the Title Insurance Rate Service Association, Inc. rate manual defines how to determine your amount of insurance. Depending on what your mortgage amount is, your premium will be calculated by multiplying a standard rate per thousand.

If you have any questions about title insurance, please contact us at Kanen Law.

Kanen Law Firm | New York Real Estate Attorneys | 90 Park Ave NY, NY 10016| Info@kanenlaw.com

Co-op Financials are Important

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The financials of your co-op are extremely important. Your board of directors mails them to you once a year, usually in the spring, and there is a very good reason they mail them to you– because you are suppose to review them!

As a shareholder of the co-op corporation, the financials are very important to you because they are the main indicator of the financial health of your shares, i.e. your co-op apartment. Simply put, the healthier your co-op’s financials are, the more valuable your apartment is and the less likely there will be maintenance increases or assessments imposed. Read more…