We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1                                                

I have a prospective tenant who wants to do a lease/option. The couple advised me that they intend to declare bankruptcy in a month or two due to $200,000 in medical bills (open heart surgery). Am I nuts to even consider them for my house? What effect will the bankruptcy have on their requirement to pay rent? If I need to evict them will they be protected in any way?
I would appreciate any advice.

A1

You might be nuts if you consider renting to them before they actually file for bankruptcy with the Court, as listing you as a creditor may result in your losing anything owed to you at the time of filing, whether they file in a month or a year. How their filing might otherwise affect you will depend on a number of factors including which Chapter they file under. A bankruptcy will require you to file a Court action to remove the stay as it applies to rent. There are a number of factors that can change what happens between the time of filing and final disposition.

After the bankruptcy is filed (usually a few months) they may be your best potential tenants because they can’t file again for a relatively long period thereafter, whereas, tenants who have not yet filed can file at any time. However, you would still need to know the details of the bankruptcy. For example, if a Chapter 11 or 13, can they afford rent on top of the Court-mandated payments to old creditors which can last for years?

Keep in mind that the idea of them paying you a lot of rent in advance, in the unlikely event they are even able to do so, in order to cover the pre-bankruptcy period has three potential problems. First, some states limit the amount of advance rent a landlord can require, second, they may not file until after that advance rent is used and they owe more, and third, the Bankruptcy Court could consider it an attempt to defraud other creditors and make you turn part or all of the funds over to the Court. Regarding the last item, a bankruptcy filing includes providing information about certain expenditures within a period before filing and rent paid in advance could technically be an asset for the tenant. The risk depends on a variety of factors including the honesty of the tenants.

Regarding doing a lease/option, keep in mind that the option might be considered an asset by the Bankruptcy Court, meaning any option payment could be treated as was discussed regarding advance rent above, or the contract itself could theoretically be assigned to someone else if it really had value (e.g., values increased significantly during the period of time that the bankruptcy action was in Court).

Most of the issues raised above and certain others potential problems probably have a low probability of occurrence, but they theoretically could cause you some stress, extra work, and/or financial loss.

The bottom line, unless there is absolutely no other possibility of finding an acceptable tenant, you should avoid doing the deal.

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Q2

I have a house which was being rented out to 2 people as unrelated roommates One of the individuals gave us a check for his half of the June rent and then it bounced. The other individual has stated that the pair had an argument and that she hasn’t seen him for weeks even though his belongings are still in the house. She is currently looking for a new roommate, but my problem is as follows: I know that she can’t make rent on her own, but if I do allow her to get a new roommate when he still has items in the house what kind of issues could I face? His name was placed on the lease as an afterthought and we neglected to have him complete an application initially (a rookie mistake). She filed a missing persons report on him but the police closed the case on the word of one of his previous co-workers.

A2

There are several issues. One is collecting the rest of the rent. Another is terminating the tenancy of the departed person. Yet another is the personal property left behind by the departed person. I am limited in discussion of all the issues in this forum, but will give you some things to consider.

Regarding collection of the rent, a good lease makes each tenant jointly and severally liable for the entire rent and the statutes of some states accomplish that whether or not the lease contains the desired clause. Accordingly, depending on the facts of the lease and/or state law, you may be able to serve a “pay or quit” notice on the remaining tenant, evict her if the amount is not paid, and obtain a judgment against her for the total of unpaid amounts, including any damages to the property.

In most cases, even if you choose to not pursue the remaining tenant at this time, she may remain liable for the missing rent and any damages, depending on the original lease and what you do when allowing a new roommate in.

Unless the departed tenant has done something showing his intent to terminate tenancy, you may have to evict that tenant in order to obtain legal possession so that you can lease it to a replacement. Unless you have legal possession, the tenant could potentially later return and claim right of occupancy.

That will require being able to (1) serve him with a pay or quit notice, which is possible to do in some states without actually finding him, and (2) serve him with the complaint & summons, which will usually require locating him.

Whether there is a need to evict the missing tenant is an issue depends on the law of your specific state and various facts of the matter. For example, if a creditable witness would testify that the person stated his intent was to break the lease and not return as a tenant, you would have a defense in court. As another example, removal of all belongings would have shown intent.

Similarly, how the departed tenant’s personal property must be handled depends on whether the person intended to abandon it and whether you can prove such was his intent. Each state has different abandoned property laws and they vary significantly among states. Some states allow the landlord to dispose of it as the landlord wishes, while other states require specific procedures be followed including secure storage, publishing of legal notices, public sale, and/or other specific items. Again, if the departed tenant intended to abandon the property left behind, there may be no problem. However, tenants who leave belongings have been known to return and claim that junk the landlord disposed of was actually valuable antiques

The bottom line is that a landlord must know the laws of his/her state regarding the various issues. How much a landlord must be concerned about issues such as I’ve raised depend not only on the laws of the state and the facts of the matter, but also on tolerance of risk.

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Q3

My partner and I split everything related to operating our rental property 50/50. Recently, I’ve been having to contribute more money to capitalize the business. We’ve agreed that we’ll pay me 8% interest on these contributions. This will be paid when the building sells. Also, my wife and I seem to be doing more hands-on work at the apartments. My question involves how can our agreement be restructured to make it fairer for the partner who does more hands-on work. I’m not interested in keeping track of every minute of work.

A3

First, there is the question of whether title to the property is vested in a partnership or simply co-owned as tenants-in-common (TIC). Many times people own real estate as TIC, but consider themselves partners. For certain issues, there can be differences.

Second, I will comment that there is a difference between a capital contribution and a loan. Whether or not the difference matters and how much it matters depends on the structure of your partnership. Issues of importance can include current capital accounts and how (1) cash flow, (2) profits & losses (not the same as cash flow), and (3) upon sale, how gain and depreciation recapture are allocated.

Third, the interest being paid to you (or will be paid) may or may not be deductible to the partnership. This depends on whether you are loaning all the money to the partnership as an entity or part to your partner as an individual so that he can make his share of contribution to capital. If to the partnership, remember that you will be paying your share of the interest and that the interest will be taxable to you based on the full amount received. If it to be a loan to the partnership, it is important that it be well documented to avoid having your partner and/or the IRS call it a capital contribution.

Fourth, if the interest is accruing until the time of sale, it will not be deductible during time of ownership unless the partnership is utilizing accrual rather than cash accounting, accrual being unlikely. Also, you must be sure that the interest rate being charged doesn’t violate any usury law of your state, particularly if compounded, as compounding can create a usurious loan out of an otherwise legal one.

Fifth, you need to be careful how you and your wife compensate yourself for labor, as this will potentially open up issues regarding income tax, self employment or social security taxes, workers’ compensation insurance, unemployment insurance, and other issues pertaining to employment laws. There is also the issue of whether the labor costs are deductible to the partnership and this will depend on a number of factors, including how it’s handled. You should clear your plans with your accountant.

Sixth, there are an infinite number of ways in which the partnership could be restructured and further discussion of the subject is way beyond this format. You should consult a competent business attorney regarding the matter.

The bottom line is that, as with many things, nothing is every as simple as it seems and the devil is in the details, particularly when income tax issues are involved.

Finally, I would comment that you should seriously consider vesting ownership of each separate rental property in a separate limited liability entity (typically a LLC) in order to limit your losses to only your equity in a single rental property in the event of a judgment by a tenant that is in excess of your insurance coverage or for an event not covered by your insurance. Otherwise, every asset (current and future) as well as future income of each partner is at risk of loss to satisfy the judgment. Any good attorney should be explaining to you why it is extremely important that you do so. An LLC can also provide more flexibility regarding certain income tax issues than can a partnership.

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

What constitutes a illegal apartment. We have a 1-family house. Upstairs we have a living room, bedroom, and bathroom. We added cabinets, refrigerator, and small electric plug-in stove. We have been told by a friend that it is illegal. Why is it called illegal? Is it because we charge rent for it? Is it legal as long as only a family member stays up there?

A1

There are a number of issues that can make a living space illegal. Some would be illegal only as a rental, while others would be illegal even if occupied by a family member, even by the owner.

A unit that violates zoning laws – for example two apartments in a single-family zoned parcel – would be illegal unless grandfathered because it was constructed as two apartments when a different zoning allowed such use.

A unit with building code violations could be illegal. Building code violations might include improperly installed electrical wiring or plumbing, failure to have a window in a bedroom, room sizes smaller than required by law, and numerous other potential problems. Most such problems would result because construction or remodeling was done without a building permit, as a permit usually requires following all building codes and passing inspections of the work. Again it may not be illegal if constructed according to building codes in effect when the work was done even though codes have since been upgraded.

The above issues technically make the unit illegal whether the property is occupied by someone paying rent or not, although it would not usually come to the attention of the authorities unless there is a falling out among the family members, a neighbor complains about too many cars parked about, or some other issue results in someone filing a complaint.

A unit that is otherwise legal regarding zoning and building codes could be considered illegal if rented without any registration or permit required by the jurisdiction where located. Many states and/or local jurisdictions have such requirements, with significant penalties when the laws are not followed.

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Q2

Would it be worthwhile to install separate water meters for a 4-plex? If so, what would it cost?

A2

It is certainly a good idea to have tenants pay for their own usage, particularly as water rates are expected to continue rising in the future, even substantially over the long-term.

The cost of installing water meters depends on both location of the property and how the property is plumbed. The cost of the meters themselves can vary substantially, from nothing to more than a thousand dollars each. The cost of the necessary plumbing modifications and installations can also vary substantially, from a few hundred dollars to more than a thousand dollars per unit, depending on how the building is plumbed.

If installing separate meters, where each tenant is responsible to the water provider for the unit’s bill, is not economically feasible because of the cost of the meters, you could consider sub-metering, whereby you obtain meters from other than the water provider at a significantly lower cost and you collect from tenants for their fraction of total usage as shown by the existing meter for the entire building. However, the necessary changes to the plumbing system might still be prohibitive. The only way to determine the costs of the two approaches is to (1) get meter prices from both the water provider and sub-metering vendors, (2) check out the current plumbing to get a preliminary idea of modifications that will be necessary so that you can judge estimates from plumbing contractors, and get estimates for the necessary plumbing modifications from qualified contractors.

Another solution that is relatively low cost, though somewhat less desirable, is that you allocate water usage among the tenants in accordance with some quantifiable and equitable method. One method often used is to allocate according to number of occupants. Since most water uses vary in proportion to occupants, this is usually considered more equitable than basing allocations on unit area or even number of bathrooms. Preventing the use of common area water for washing vehicles can help keep the landlord’s water costs down.

Keep in mind that, no matter which route you go, you would not be able to change the terms of a lease during the lease period or with the required notice for month-to-month tenants, usually 30 days.

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Q3

I have a tenant that is granted mercy living rights to a home because she has a few things in the house and has mail coming there. She never did actually live there, but the person that did died and now they are trying to say they lived there. Do I have any rights at all over this person? I am also executor of the will of the legal occupant.
I plan to evict, but want to know if I can go in as soon as she says she has all her stuff and change the locks.

A3

With over 30 years in the real estate management business in several states, I have not before heard of “mercy living rights.” Is this something provided by statute in your state or something provided by the lease agreement? Also, you say that you represent the deceased occupant, but don’t state whether the deceased was the owner or a tenant, with the remaining person claiming to be a tenant having been a co-tenant or a subtenant.

Your rights may depend on a number of details that you do not mention, so I can’t respond to the general question of what rights you might have. You call the remaining person a tenant and if the person is a tenant you should have all the rights granted under the statutes of your state if the deceased was the owner.

In general, if the tenant has vacated the premises and the deceased was the owner, you can probably take possession and change the locks. However, if there is any question regarding whether or not the tenant has vacated, you need to be careful. Evidence of vacating might include turning in the keys and removing all belongings.

If you are not familiar with those statutes, I recommend that you consult a competent landlord-tenant attorney rather than doing something that might cause problems for you.
If you wish further help, you’ll need to provide additional details, including answers to questions I’ve raised.

When Co-Tenants Split

Many, perhaps even most tenants are co-tenants with other persons. Sometimes the co-tenants are spouses or relatives by blood, other times the co-tenants have no legal relationship beyond their tenancy. Renting to unrelated parties can result in problems for the landlord that are not usually seen with renting to a single adult, a husband and wife, or two siblings. However, there is sometimes no choice except to do so. There are a number of circumstances that might make it necessary or beneficial, including (1) it may be required under fair housing laws, (2) a college area location may mean that this is your primary pool of potential tenants, or (3) a bad economy may push people into shared arrangements.

Similarly, there are many possible reasons why co-tenants might want to or need to cease living together in the same rental unit. Specific reasons include:

• Separation and/or divorce for spousal co-tenants   
• Non-spousal co-tenants no longer get along
• Financial difficulties
• Change in plans

Separation and/or Divorce – If a married couple separates and/or divorces during the term of a lease resulting in one of the residents departing, the landlord is well advised to evaluate the credit worthiness of the remaining resident before deciding whether or not to renew the lease. If the lease is renewed without the signature of the former spouse, the landlord may be deemed to have released the former resident from liability and will only have recourse to the assets of the spouse who remains as the resident.

No Longer Get Along – It is not unusual that non-spousal co-tenants find that they can’t live together peacefully and one or more wish to leave. This is particularly true when the parties have not previously tried living together. There can be a big difference between being friends with a person and living with that person. The issues of money and property use can create stress and strain upon a relationship.

Financial Difficulties – Sometimes a co-tenant can no longer meet his/her share of the financial obligations. This may be due to loss of employment, change of employment with reduction in income, or increased expenses (e.g., medical).

Change in Plans – The plans of one or more co-tenants may change during the term of the lease. This may be due to a change in employment location, transfer of schools, or any number of other personal reasons that require a change in address.

Leases Agreement Issues
There are a number of issues regarding residential lease agreements that can be of importance regarding co-tenants, including the following:

All occupants of legal age should be required to sign the lease. This should include both spouses of a married couple because, in some states, the assets or income of a spouse who has not signed the lease agreement cannot be subject to collection of any judgment.

Although most states make co-tenants jointly and severally liable by statute, the lease agreement should still contain the clause because the tenants then cannot claim to be unaware of their liabilities.

Unless prohibited by law, the lease agreement should require written consent of the landlord to a tenant’s request to sublet or assign the rental unit or to replace one co-tenant with another.

The agreement should include clauses regarding the security deposit and rent payment issues discussed below.

Replacing or Adding Co-Tenants

If a co-tenant leaves and the residents find a replacement resident who is accepted by the landlord, then the landlord can agree to the replacement subject to the applicant meeting the landlord’s qualifying criteria.

The proposed replacement or additional co-tenant should be required to submit a rental application, pay any usual application and screening fees, and consent to the landlord’s standard tenant screening process.

Upon acceptance of the new co-tenant by the landlord, a new lease agreement or an amendment to the existing agreement should be executed by all occupants of the rental unit.

As a general rule the more individuals liable for the lease the better for the landlord. Accordingly, if a co-tenant departs during the term of a lease, there is seldom a reason why the landlord should release that person from responsibility during the original lease term even when another person replaces him as co-tenant.

In the case where a departing occupant will not be replaced, landlords may also want to consider financially re-qualifying the remaining occupants regarding their joint ability to pay the rent. However, one must be careful to consider familial status issues under fair housing laws.

Security Deposit

Allocation of security deposit shares among old, new, and remaining co-tenants should usually be left as a matter between those parties. The landlord is not legally required to release any of the security deposit until all lease terms are met and the tenants have vacated the rental property. The new co-tenant usually should not pay a security deposit to the landlord. The landlord should return the security deposit only to the last person on the rental agreement to leave the apartment.

For protection of new, departing, and remaining occupants, it is a good idea that a walk-through inspection be performed and a checklist be completed. If a new lease is being written, it is recommended that the landlord collect reimbursement for damages to that date so that the continuing occupants can properly settle up with the departing co-tenant and start out with a clean slate and minimize damage claims later, a benefit to all parties.

Rent Payment

The landlord should only accept one full security deposit (in cash or bank check) and the FULL rent each month from one person. The residents can fight it out among themselves for the “privilege,” but if anybody offers partial rent, the landlord should refuse to accept, referring them to the lease agreement which should so specify. Accepting multiple separate checks can result in additional problems if one or more, but not all, bounce.

Unauthorized Occupants

If the landlord discovers that a replacement or additional occupant has been added in violation of the lease agreement, the landlord should immediately take action to end the stay or qualify the occupant as a co-tenant. Unreasonable delay may be construed to have indicated approval of an assignment or sublet without the landlord being able to exercise the usual control.

Co-Tenant Agreements

By utilizing a separate written agreement among the co-tenants, they may be able to lessen misunderstandings and disputes among themselves. The landlord should never be a party to such agreements and should never become involved in the writing or enforcement of them. So long as not a party to such an agreement, the landlord is not bound by the agreement.

Lease Defaults

It is important to remember that only landlords can evict tenants. A co-tenant cannot evict another co-tenant. Co-tenants cannot change locks to bar other co-tenants from access to the rental unit. Lease clauses customarily and should state that tenants will be in violation of the lease if they change locks without the landlord’s permission. Violations of the lease may result in eviction of one or all occupants. A default by any one occupant may result in the eviction of all occupants.

The landlord must decide whether to evict all occupants in those situations when the breach of the lease was for a reason other than nonpayment of rent. Certain circumstances could dictate that only the offending tenant be served with eviction. As a practical matter, the eviction of one tenant may impose a financial hardship on the rest of the occupants, resulting in nonpayment of rent. The breach of the lease by nonpayment of rent should always result in service of a “pay or quit” notice with nonpayment triggering initiation of the eviction process.

Domestic Violence

Many states and cities have special protections for victims of domestic violence. The landlord should become familiar with applicable statutes and know what action to take accordingly. Some states have an antidiscrimination statute that says the landlord cannot refuse to rent to or terminate a lease simply because the individual is a victim of domestic violence. In some states, the victim may have early lease termination rights and may end the lease without giving the customary amount of notice. Landlords in some states are prohibited from terminating the lease of a tenant who calls police for help in a domestic violence situation.

In Review

In Part 1 of this 3-part series we discussed the reasons why every business, including the real estate rental business, should have a disaster plan and the preliminary steps to take toward developing an emergency action plan. In this part of the series we briefly discuss the development of the plan.

Develop a Plan

An emergency action plan is your plan to stay in business. An emergency action plan is a written procedure for dealing with the threats you’ve identified. Some components of your plan will be prescribed by statute or regulations, while others will be based on good business sense.

The three main components of an emergency management plan must address the issues of human resources, physical resources, and business continuity. Many parts of the plan will be common to most disasters. You do not have to have a completely separate plan for earthquakes, power outages, or tropical storms, although the details may vary somewhat.

The small business owner that operates from a physical business office location has already given some thought regarding who to call “in case of emergency” by designating emergency contact information provided to law enforcement or city business registration offices. In many jurisdictions this is actually required to be posted in a prominent location, usually on or near the front door, to show who to call when the security alarm goes off, the front door to the office is left unlocked, a passerby notices an apparent break-in, or some other event. If you have designated an emergency contact, it is advisable to make sure your contact person knows that he is the designated contact and, just as importantly, is willing to accept responsibility for that task.

The contact person is usually a person that you trust as a family member, an associate, or a reputable service agency. Consider having that family member or associate assist you in writing a complete emergency management plan. Despite the complexity of some businesses and the need for a more detailed disaster plan, there are really only four basic events to plan for. When you write your plan, consider what to do if:

• Part of your business is disrupted or become unusable,
• Your entire business, structure and contents, is destroyed,
• There is a significant disruption of business services such as power outages, and
• Your business is in a geographic area that is rendered uninhabitable for an unknown length of time.

There are a number of different ways to create your emergency plan; however, all emergency plans tend to have the same basic elements. According to the National Safety Council, emergency actions plans should contain the following minimum elements:

• Clear, written policies that designate a chain of command, listing names and job titles of the people or departments who are responsible for making decisions, monitoring response actions, and recovering back-to-normal operations.
• Names of the people responsible for assessing the degree of risk to life and property, and who exactly should be notified for various types of emergencies.
• Specific instructions for shutting down equipment and production processes and stopping business activities.
• Facility evacuation procedures, including a designated meeting site outside the facility and a process to account for all employees after an evacuation.
• Procedures for employees who are responsible for shutting down critical operations before they evacuate the facility.
• Specific training, practice schedules, and equipment requirements for employees who are responsible for rescue operations, medical duties, hazardous responses, fire fighting and other responses specific to your work site.
• The preferred means of reporting fires and other emergencies.

Your procedures should be completely documented in writing. They should be specific, detailed, logical, and follow an orderly progression. To be effective, your plan should be understandable and readily interpreted by the average person, using a “plain English” style in a common sense format.

Even for small business owners there may be statutory and regulatory requirements that govern what actions to take in an emergency.

To be effective, the plan should make sense for your particular business. The value of good, common sense cannot be discounted when writing your plan. A plan that looks good on paper, with lots of words and diagrams, is meaningless if it doesn’t take into account the true operations of your business.

Common sense business planning for any size and type of business must include document safeguarding. What customer or client information records are kept? In what format? In what location? Are records backed up on a regular basis? Where are the backup copies kept?

Loss of business records could be a costly event. Financial data, insurance policies, deeds, contracts, and other business information are typically stored onsite. A section of your disaster plan should address the issue of loss prevention of vital business records. Some documents could, of course, be re-created or copies obtained from official records, but that could be costly and delay reopening the business.

Are there other business documents that if lost or destroyed could put you out of business such as vital information that is critical to the operation of your business, original documents that do not exist in another form or copy, or data retention required by law?

There are various safeguards for record protection including, printed copies stored elsewhere, fireproof watertight storage containers, scanned document files stored on the Web or on portable devices stored elsewhere.

Insurance

Insurance is an important component of any risk management and disaster preparedness planning. Insufficient or failure to provide the right kind of coverage can in spite of the rest of your good efforts, wipe out your business.

In general, the basic business insurance package consists of four fundamental coverages. They are workers’ compensation, general liability, auto, and property/casualty. There is also an added layer of protection over those, often called an umbrella policy. In addition to these basic needs, one can consider business interruption coverage and life and disability insurance.

Insurance is not a one-size-fits-all issue. You need to understand what your risks are, how much liability you can handle, and what you need to cover. A good insurance agent is important to this task.