Selecting a Property Management Company

There are numerous possible reasons why real estate investors need to hire a property management company. Some investors need to utilize a management company because they want to reap the benefits of real estate investment without personally managing their properties or cannot do so because of other business or employment commitments. Other investors have no choice except to utilize a management company because the property is at a distant location.

However, using a management company can in itself potentially create new risks for an investor and result in unexpected financial and/or legal problems. Use of a property manager does not eliminate an investor’s liabilities related to ownership and operation of the property nor does it guarantee that the property will be managed efficiently and profitably.  Accordingly, selecting a management firm requires considerable care and adequate due diligence.

A property management business that is both competent and profitable requires a team effort. Thus, you will probably want to utilize a qualified full-service property management company. Most qualified property management firms will be a multi-person business in some legal format, usually either a corporation or limited liability company. However, for brevity, the term “manager” will be used hereafter.

The most important thing to remember is that you will have employed someone who has the authority to act on your behalf and that you will be liable for all acts performed by that agent in exercise of the authority you have given. Accordingly, it is extremely important that you choose a company that is honest, competent, and experienced and that the contract between the two of you adequately defines and restricts the authority given to the manager and defines the duties of both parties.

Good management requires a significant amount of knowledge, a lot of work, and good organization. Profitable management requires that the management company have adequate qualified personnel to handle the work load and the tools necessary for doing so efficiently. For example, may states require use of a “resident manager” for a complex having more than a specified number of units – e.g., greater than 15 in CA – and the resident manager must be an employee (as
defined by federal and state laws) who is adequately supervised and for whom payroll must be done.

Many real estate brokerage firms offer property management services even though the primary business is brokerage, perhaps only home sales. However, real estate companies that do not include a serious property management division may have limited knowledge and experience, have limited or no access to screening reports, and may not have documentation available and procedures in place that are both functionally adequate and in compliance with all current laws.

Selecting a good manager can be one of the more important decisions you will make regarding your rental property.  Accordingly, owners should do as much due diligence as they consider necessary to ensure that the selected manager will manage their properties in a manner that is (1) at all times in compliance with all federal, state, and local laws and regulations, (2) efficient and long-term cost effective, and (3) results in long-term increasing cash flow and market value.

All states regulate many aspects of real estate transactions. In most states, a Real Estate Broker license is required for any individual or company that, on behalf of another and for valuable consideration, engages in property management including advertising real estate for lease, procuring prospective tenants, negotiating lease terms, or executing lease agreements. While most states license property management under a real estate broker license, a few states provide for a special property management class of license.

Before proceeding to interview each candidate management company, you need to first verify that the company is properly licensed and determine whether or not any complaints have been filed against it or any disciplinary actions have been taken against it. Check out each candidate via a phone call to the state’s real estate license regulatory agency or on the agency’s Web site. In particular, be sure that there have been no material trust account regulation violations.

For each management company meeting these criteria, you next proceed to look at the following specific qualifying issues.

• Property Type Qualified – Is the company qualified to manage the type of property you have? It is usually necessary that a firm have a significant number of units under management in order to be able to afford the personnel and tools
  necessary for efficient and adequate management of properties. However, although the number of units is one preliminary indication of the firm’s qualifications, the number of units managed is usually not more important than
  the firm managing properties of a type similar to yours.
• Staff requirements – Consider each kind of service you want the company to perform for you. This will usually include: finding, screening, and selecting tenants; executing leases; holding and accounting for deposits; collecting rents; handling tenant complaints; dealing with emergencies; supervising routine maintenance and repair; and providing financial accounting and reporting. Does the company have adequate qualified staff to add your property to their current management load?
• Personnel- Are personnel who perform tasks that require licensing, properly licensed?  Are at least key personnel highly experienced? Is adequate effort put into keeping up with laws and regulations related to property management?
• Management Contract – It is important that the management contract you will sign be fair to both parties. There are things that must be included by law in most states, things that should be included to protect you as owner, and things that should not be included.
• Screening & Selection Procedures – The most important functions a manager is likely to perform for the property owner is tenant screening and selection. A bad tenant can cost you thousands of dollars and ruin your day. Worst case, improper screening and selection procedures could cost you everything you own and ruin your life.
• Documentation – Legal and adequate documentation is extremely important for minimizing management problems and dealing with problems that do occur. You will want to obtain copies of all documentation used by a candidate manager and satisfy yourself as to adequacy.
• Management issues – Does the company have adequate operational and management procedures in place? Does the company employ technology that results in efficient and cost-effective management and that provides adequate reporting?
• Maintenance Issues – How is maintenance handled by the management company? Does it utilize employees or independent contractors or a combination of both and does it do so in accordance with IRS rules and other legal requirements?

You must always remember that the manager Is your agent. What you see when interviewing a candidate gives you some indication of what you are likely to get, but we have all learned that looks can be deceiving. Select a property manager based on qualifications that have been verified, not because of a nice smile or a fancy office. The fact that the manager is your agent means that:

• The property manager will essentially control your investment;
• The manager represents you with your customers, the tenants;
• The manager represents you with governmental agencies;
• The manager handles the tenants’ money and yours

As your legal agent, the manager can, through incompetence or negligence, get you embroiled in lawsuits regarding a variety of issues including (1) physical injury, (2) property damage, and/or (3) personal injury; and

The manager can get you into trouble regarding other issues that can involve both lawsuits and governmental agencies, including those related to violation of landlord-tenant, fair housing, fair credit reporting, lead-based paint, and other laws at federal, state, and/or local levels.

Finally, owners should regularly monitor the operation of their properties and discuss problems and questionable issues with the manager. In addition to reading furnished financial reports and contacts via phone and email, owners should regularly visit their property. Depending on location and other factors, “regularly” might mean monthly, quarterly, or annually. More often is better than less often.

Question 1

I am considering using Section 8, but wonder how rents are set.

Answer 1

Fair Market Rents (FMRs) determine the eligibility of rental housing units for the Section 8 Housing Assistance Payment (HAP). FMRs are gross rent estimates. They include the shelter rent plus the cost of all utilities, except telephones.

The U.S. Department of Housing and Urban Development (HUD) defines FMR areas as metropolitan areas and non-metropolitan counties. FMRs are intended to be housing market-wide rent estimates that provide housing opportunities throughout the geographic area in which rental units are in direct competition.

HUD sets FMRs to assure that a sufficient supply of rental housing is available to program participants. To accomplish this objective, FMRs must be both high enough to permit a selection of units and neighborhoods and low enough to serve
as many low-income families as possible. The level at which FMRs are set is expressed as a percentile point within the rent distribution of standard-quality rental housing units. The current definition used is the 40th percentile rent, the dollar amount below which 40 percent of the standard-quality rental housing units are rented. The 40th percentile rent is drawn from the distribution of rents of all units occupied by recent movers (renter households who moved to their present residence within the past 15 months).

HUD sets fair market rents annually for units with different numbers of bedrooms. In most areas, the fair market rent is set at an amount sufficient to pay rent and utility costs for 40 percent of the recently rented units in the area, excluding new units. In certain metropolitan areas, HUD sets the fair market rent at the 50^th percentile instead.

Reasonable Rent is certified by the housing agency for each household that is subsidized. What this means is that the rent cannot be more for a subsidized unit than it would be for an unsubsidized unit, comparable in size, amenities and geographical location.

The rent a landlord charges must be reasonable under HUD standards. If rent is reasonable, the local housing agency calculates the gross rent for the unit which is the amount of rent requested by the landlord and the utilities the tenant must pay (utility allowance based on the size of unit and type of utilities unit used—natural gas, oil, electricity and water; then the gross rent (unit rent and utilities) is compared to the payment standards established by HUD (based on unit size). If the gross rent is less than the payment standard for the rental unit, then the rent is affordable and may be approved; if more, the family may be permitted to pay the excess amount as long as the amount does not exceed 40% of the family’s monthly adjusted income

If the local Public Housing Authority (PHA) determines that the rent charged by the landlord is not reasonable and the landlord refuses to lower the rent, then the agency will tell the family to search for another unit.

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Question 2

Should I be concerned about having earthquake insurance for my rental properties?

Answer 2

Unless the lender required earthquake insurance, each property owner must assess the risks of going without the coverage vs. the cost of the coverage. The risk of earthquake damage depends on the location of the property, the type of
property, date of construction, and the improvements made after construction specific to reduction of damages.

It should be obvious that earthquakes can have different magnitudes and occur at different distances from a property. In general, as either the magnitude goes up or the distance decreases, the severity of shaking increases. Those residences that are relatively close to an active fault are more likely to suffer damage, although there can be exceptions due to numerous reasons. Thus, even though the probability of a magnitude 6 earthquake someplace in a particular region is as
high as 8% per year, the probability of it being close enough to damage your property is smaller. NOTE: Earthquake magnitudes are rated on the Richter scale which is logarithmic rather than linear. Without getting into the actual math
of it, the energy released by a magnitude 7 quake is 10 times that of a magnitude 6 quake and 100 times that of a magnitude 5 quake.

For a well-built wood-frame house or other building, the deductible will generally exceed the structural loss for most moderate earthquakes. Due to good design, in recent earthquakes the damage to structures is a smaller part of the total loss than the damage to contents.

There are various possible improvements that will prevent or at least reduce impact of certain types of potential damages. Many improvements are relatively inexpensive compared to the protections afforded. For example, about $25 will greatly reduce the chance of an earthquake causing the hot water heater to tip over and both irreparably damaging the heater and damaging pipes, resulting in also extensive water damage.

Earthquake insurance is catastrophic insurance and therefore deductibles are relatively high.  Deductibles are generally in the form of a percentage rather than a dollar amount. Deductibles can range anywhere from 2 percent to 25 percent of
the replacement value of the structure. Insurers in states like Washington, Nevada, and Utah, with higher than average risk of earthquakes, often set minimum deductibles at 10 percent or higher. With a 10 percent deductible, if it cost $1,000,000 to rebuild a property the owner would be responsible for the first $100,000 dollars. In most cases, owners can get even higher deductibles to save money on earthquake premiums.

This limit works much like the deductibles on your auto insurance. The result is that the insurance pays only for damages that exceed the deductible. However, unlike car insurance, some earthquake policies treat contents and structures separately. This means the deductible amount applies separately to the:

• Total amount of the loss for contents
• Total amount of the loss for the structure
• Total amount of the loss for unattached structures like garages, sheds, driveways or retaining walls

Not all policies are alike. You should compare the coverage differences between companies to get the coverage that best meets your needs.

Premiums vary widely by location, insurer, the type of structure that is covered, and, of course, the deductible amount. Generally, older buildings cost more to insure than new ones. Wood frame structures generally benefit from significantly lower rates than brick buildings because they tend to withstand quake stresses better. Regions are graded on a scale of 1 to 5 for likelihood of quakes, and this may be reflected in insurance rates offered in those areas.

Although an earthquake is the first thing that comes to mind when someone mentions earth movement, this very broad category also includes landslide, mudslide, mudflow, sinkhole, or any other movement that involves movement of earth. Loss caused by these hazards may be covered if the damage resulted from an earthquake. An earthquake endorsement generally excludes damages or losses from floods and tidal waves – even when caused or compounded by an earthquake.

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Question 3

I’m refinancing my rental property. Why do I need to pay for another lender title insurance policy when the same lender was provided a policy when I got the original loan?

Answer 3

The lender’s policy is sometimes referred to as the loan policy. A lender’s policy covers the cost of defending insured matters against attack. As to be expected, lender policies will except or exclude certain matters and are subject to various
conditions. In general, the lender’s policy follows assignment of the mortgage loan, meaning that the policy benefits the purchaser of the loan if it sold.  This is of value to lenders and greatly facilitates the sale of mortgages into the secondary markets.

Lender’s title insurance, however, does not cover events beyond the time of escrow closing. Title insurance is required by a lender when you refinance your mortgage loan. When you refinance, you are obtaining a new loan either from your original lender, as in your case, or a new lender. Even though ownership of your property has not changed, and you remain protected by the owner policy from your original purchase date, the title policy purchased for your original loan does not insure the new mortgage created by the refinance. The new lender or the same lender requires title insurance to protect its investment in the property. The existing lender’s policy terminates when you pay off the mortgage.

Your owner’s policy remains in effect for as long you and your heirs (or certain “related” parties) retain an interest in the property. However when you refinance your mortgage, the conditions under which the lender’s policy was issued have changed. Protection against events that may have transpired between the times you purchased the property and the date it is refinanced is an issue that must be addressed by the new lender. The lender needs reassurance that the title to the property they are financing is clear or as otherwise agreed.

Examples of such events may be a second mortgage taken on the property that could jeopardize the priority of the new lender’s mortgage, legal judgments for unpaid taxes or child support, or mechanic’s liens filed against the property for contractor’s claims for work done and remaining unpaid by the owner.

Asset Protection – Part 1

Although sometimes considered an approach to risk management, asset protection is actually a subset of risk management. Good risk management includes a number of issues in addition to asset protection. Asset protection becomes important primarily when other risk management measures have not been totally effective.

Some risks can be avoided or eliminated, others can be controlled or minimized, still others can be transferred to someone else, and some can and should be retained. Part 3 of our past Risk Management series of articles discussed the
risk management approach of transferring risks to others, the most common method being that of insurance.

Many real estate investors assume that their assets are protected because they have business insurance on their rental properties and maybe even umbrella policies.  Unfortunately, they are wrong. For a long time now, judges and juries have been awarding outrageously large judgments for personal injury lawsuits and there is little chance that this will change in the future. In fact, judgments will likely increase at least as fast as real estate values.

Accordingly,  landlords must understand that having liability insurance policies, no matter how high the coverage limits, doesn’t necessarily provide adequate protection in the event of a large judgment. Two or three million dollars of insurance
coverage doesn’t help much when a judgment is many millions of dollars.

All assets held in the name of an individual are at risk in the event of a judgment resulting from an event related to any one rental property owned by the individual or from any other cause for litigation. Assets at risk include rental properties, personal residence, stocks & bonds, bank accounts, and all other personal property of value (jewelry, furnishings, antiques, art, autos, boats, etc.).

Insurance coverage is necessary and provides protection against many claims, but it is usually cost-prohibitive to attempt to fully protect all your assets against every possible risk with insurance at a cost that is practical. Even if you
spent the money in an attempt to cover all assets regarding all possible risks, you could still discover in the end that it provided inadequate protection.

Risk of loss of assets other than the property that is the subject of a lawsuit is greatly reduced by having rental properties vested in a limited liability entity.

A variety of limited liability entities are available in most states. Typically, these are:

• Corporation
• Limited Liability Company (LLC)
• Limited Liability Limited Partnership (LLLP)
• Limited Liability Partnership (LLP)

Although the general partners of a General Partnership or a Limited Partnership have historically been personally liable to creditors, the Limited Liability versions of those entities, where available, provide protection also to the general partners.

Each type of limited liability entity has somewhat different operation requirements and tax issues. Which entity is best depends upon a number of factors. Not all entities are available in all states or defined identically where available.

Although the discussions of this article apply similarly to any limited liability entity, we’ll discuss only corporations and limited liability companies because they are basically quite different from one another, while the non-corporation entities are quite similar to one another. Furthermore,  after initial discussion of corporation basics, we’ll use the term LLC in our discussions because (1) it is the form currently most used for ownership of real properties and (2) most discussion is applicable to all types of limited liability entities.

Corporation

A corporation is created under state law and is treated by law as a legal entity. It has a life separate from its owners and has rights and duties of its own. The structure and powers of a corporation are defined in its Articles of Incorporation and its By-Laws. The owners of a corporation are the stockholders. Stockholders elect a Board of Directors, which in turn hires Officers who are responsible for day-to-day operations of the corporation. Board members and Officers may or may not be stockholders. Forming a corporation involves a transfer of money or property, or both, by the prospective shareholders in exchange for capital stock in the corporation. For the purpose of federal income tax, corporations include associations, joint stock companies, trusts, and partnerships that actually operate as associations or corporations.

There are two basic types of corporations, ‘C’ corporations and ‘S’ corporations. They are the same for most purposes except for income tax treatment.

‘S’ corporations are domestic small business corporations that can avoid double taxation by electing to be taxed under Subchapter S of the Internal Revenue Code. A maximum number of shareholders is allowed while qualifying for ‘S’ status and only certain individuals and entities are allowed to be shareholders. These limitations would not be of concern for most real estate investors and tax issues usually dictate use of non-corporate entities.

For ‘S’ corporations, income is taxed in a manner similar to that of a partnership. In general, an ‘S’ corporation does not pay tax on its income. Instead, the income and expenses of the corporation are divided among its shareholders, who then report them on their own income tax returns. Generally, an ‘S’ corporation is exempt from federal income tax other than tax on certain capital gains and passive income.

An ‘S’ Corporation must pay reasonable compensation (subject to employment taxes) to shareholder-employees in return for the services that the employees provide to the corporation, before  non-wage distributions may be made to those shareholder-employees. Therefore, shareholder-employees cannot avoid employment taxes by taking all compensation as dividends or other payments that are not as heavily taxed. The IRS has recently identified this issue as an area of non-compliance and will likely be looking at it more closely in the future. In both types of corporations, profits and losses are shared in proportion to the number of shares owned.

Unlike a partnership, flow-through income from an ‘S’ corporation is not subject to self-employment tax (Revenue Ruling 59-221, 1959-1C.B. 22). In direct contrast, a partnership’s flow-through ordinary income is generally subject to
self-employment tax.

A ‘C’ corporation is a regular corporation. Profits and gains are taxed at the corporate level and dividends paid to shareholders are taxed to the shareholders, thus, double taxation. Employees – whether shareholders, directors, officers, or none of those – pay income taxes on compensation the same as if they were employed anywhere else. A ‘C’ corporation is not normally considered a vehicle specifically for real estate investment purposes, although there are sometimes reasons why one would utilize a ‘C’ corporation rather than an ‘S’ corporation, particularly when an operating business is involved rather than passive investment in real property.

Maintaining the liability protection of a corporation requires strict adherence to various procedures including those related to record keeping and meetings.

The governmental costs of forming and maintaining corporations vary significantly among the states.

Limited Liability Company

All states have enacted limited liability company (LLC) statutes. An LLC is a separate legal entity formed by filing Articles of Organization with the Secretary of State. LLCs (and similar entities called Limited Liability Partnerships – LLPs) combine certain features of partnerships with certain features of corporations, most notably, limited liability for its owners and managers. LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.

The individual members are not personally liable for the LLC’s debts, except to the extent of their investment and capital commitment in the company. It is important to note that an LLC is not a federal tax entity and is generally treated as a partnership by IRS. Most states also permit “single member” LLCs, those having only one owner. A single-member LLC can be treated as a “disregarded entity” for tax purposes, even though still respected as separate for legal purposes. Thus, if owned by an individual, an LLC can be reported as a Schedule C sole proprietorship on the owner’s personal tax return. There are certain circumstances when courts have recently allowed piercing of the “corporate veil” specifically for
single-member LLCs and accordingly, there is a benefit to having a spouse or other person being a member.

Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs, and foreign entities. There is no maximum number of members.

Another advantage of an LLC over a corporation is that LLCs have flexibility of distribution of profits and losses. One may divide up the profits and losses any way agreed upon rather than being limited to dividing them proportionate to the amounts of capital contributions.

LLCs are managed by their members unless they elect to be managed by a management group. The management group can consist of some members and/or non-members. Small LLCs are usually member-managed.

A LLC should always have a detailed written operating agreement that defines the rights and responsibilities of LLC members and managers. If you will have a manager-run LLC rather than a member-run LLC it is especially important to have an adequate management agreement. Although a registered LLC is not legally required to have written agreements and can operate on the basis of oral understandings, it can be a very big mistake to do so.

The LLC is probably the most often recommended entity for holding title to real property because it provides (1) limited liability, (2) favorable tax status, and (3) relative ease of operation.

Requirements for operation of LLCs so as to maintain liability protection are significantly less stringent than for corporations.

As for corporations, the governmental costs of forming and maintaining LLCs vary significantly among the states.

In Summary

A risk management program utilizes a number of devices including (1) practicing a variety of preventative and control measures, (2) vesting each real property in properly formed limited liability entities, and (3) having good insurance coverages. These three approaches utilized together can provide a relatively effective shield against the largest lawsuit at a reasonable cost.

Question 1

If an unmarried couple wants to rent our home can we asked that only the man who has a job sign the lease agreement. We don’t want the unemployed lady friend to have her name on the lease in case the boyfriend leaves as she has no income. If her name isn’t on the lease and he leaves her we could then ask her to leave, but if her name is on the lease then it would be difficult to ask her to leave and she has no means to pay the rent. Also can we refuse to rent to unmarried couples?

Answer 1

In my opinion, there is almost never a reason to not have every adult occupant sign a lease. However, there are numerous reasons why every adult should be required to sign, some of which are discussed herein.

Federal, state, and local fair housing laws protect against housing discrimination. Some states do allow a landlord to use unmarried status as criteria for refusing an application. You will need to research your state and local fair housing laws to determine if there is an applicable law protecting unmarried couples from housing discrimination. If allowed by law and your rental standards you must be sure to apply your standards to all applicants. Each and every applicant must be screened using the same rental criteria, in the same manner, every time.

At a minimum, landlords should require that each applicant (who can be held liable on a lease agreement) should:

• Be  of legal age (18, 19, or 21, depending on state) or an emancipated minor,
• Complete and sign a rental application,
• Sign an authorization of release of personal information form for credit reports, employment, rental history, eviction report, and criminal history, and
• Present at least two forms of personal identification, with at least one being a government-issued photo ID.

Every occupant, age of maturity or emancipated (including spouses), should be named on the lease agreement. In the event one occupant defaults, you have recourse against the other tenant. The fact that one tenant has no income at the time of application does not mean he/she cannot be collected from in the future – even if completely penniless at the time of application, he/she may later be employed, win the lottery, inherit a fortune, or marry someone of significant financial status. Judgments against a person who had no income or assets at the time the judgment was obtained can be collectable for many years later and in other states. Furthermore, if the person seeks credit at a later date (including when applying to rent elsewhere) provides leverage for payment because credit grantors sometimes require payment of judgments as a condition of granting credit.

If you do not have her sign the lease and the boyfriend leaves you can certainly “ask” the lady to leave, but if she refuses you will have to legally evict her or any other person who has moved in, potentially costing you the same time, money, and stress as if she had been a wife. This is one reason why eviction complaints should usually include “John Does” as defendants. Having the unemployed person(s) sign the lease assures the ability to obtain a judgment against that person.
In general, the more people who can potentially be held liable for rent and damages the better the chance the landlord will eventually collect what’s owed. Furthermore, assuming that the lease agreement is correctly written to make each signer jointly and severally liable, the landlord need not try to collect from each one who signed the lease, but may pick the one who has the deepest pocket at that time or the one who is easiest to find.

Again, landlords must understand that an applicant’s current financial status is not always his/her status at some later date. Those long employed at high salaries may be unemployed next month. And, as previously stated, those who are currently unemployed and have no assets may be wealthy next month.

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Qustion 2

I went to the magistrate, filed a Landlord/Tenant complaint to remove a tenant, and had the hearing at which time I received possession of the property. The tenant filed an appeal at the court house. At that time she owed $126.50 for the cost
incurred for the judgment and on the day of her appeal the rent was due in the amount of $500. She only paid for the appeal of $68.50 and nothing else. It has been 10 days since she filed and she has no money to pay anything until July. I
claim she is in default I and should be able to get possession without filing another appeal. The Prothonatary’s office will not speak to me and I think they screwed up by not getting any money from the tenant. I have only 9 days to an appeal
according to the Notice. This is in Pennsylvania. Can you give me some guidance on this?

Answer 2

An appeal usually prevents the tenant from being evicted as long as all rules governing the appeal process are followed.  One of the most important rules in most jurisdictions, unless the judge grants a waiver, is that the tenant begin depositing all monthly rent into an escrow with the court at the time the appeal is filed. Failure to open the escrow account or deposit the money in full and on time can lead to dismissal of the appeal and eviction of the tenant.

You didn’t say whether this was a requirement for your case or, if so, whether the tenant deposited the funds into the escrow account. Different jurisdictions within PA and even different judges within a particular court may have different interpretations of the statutes and procedures. Furthermore, judges sometimes let their emotions interfere with enforcing the law.

Because failure to properly follow the court’s rules related to eviction can significantly extend the eviction period, it is often more cost effective to hire an attorney who specializes in evictions on behalf of landlords, preferably with intimate knowledge regarding the particular court of jurisdiction. A competent attorney can also help maximize the amount of any judgment obtained against the tenant.

It is often best to obtain a money judgment even if the tenant leaves before completion of the eviction process because (1) judgments are good for 5 years or more in most states, (2) judgments can be renewed for addition periods, (3) interest is added to a money judgment – often at a higher rate than available from most other investments, (4) the judgment can be collected in any other state that the defendant might move to, and (5) judgments are sometimes paid off because the debtor needs to remove the item from their credit record in order to obtain a loan or rent another property.

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Question 3

In the state of PA, is it permitted to make some apartment units non-smoking?

Answer 3

Obviously, I’m not familiar with every law at every level of government in the country, so I can’t state that a particular rental property location is not subject to some weird local ordinance related to prohibition of non-smoking rules. However, I’d probably bet a lot of money against there being one.

Nationwide the trend has for many years been to limit smoking. Many states have passed laws and many local governments have passed even more restrictive ordinances against smoking in public places. Some jurisdictions even prohibit smoking in bars. In a recent report the CDC estimated that roughly 47.8 per cent of residents are now covered by comprehensive state or local indoor smoking bans.

There has in recent years been increasing action against smoking by owners and managers of properties. Management companies that manage tens of thousands of apartments and condos have gone smoke-free in the past five years, including those managed by the owners and those managed by management companies. Some municipalities are passing ordinances related to smoking prohibitions, not only in public places, but also in multi-unit housing.

Most basically, there is no federal law that prevents landlords and property managers from regulating smoking on the premises, whether inside individual units or outside in common and private use areas. I doubt that there is any state law regarding the issue. This is because (1) there is no constitutional right to smoke and (2) smoking is not protected by Fair Housing laws – e.g., HUD does not prohibit non-smoking policies in affordable housing. In fact, in 2009 HUD released a memo that encourages public housing authorities (PHAs) to implement non-smoking policies. A number of PHAs around the country have adopted non-smoking policies.

It is my opinion that landlords should specifically prohibit smoking in their units and within common areas rather than discriminate against smokers per se because it is the act of smoking in the unit that is important to the owner and the secondhand smoke in common areas that is important to other tenants rather than the fact that a tenant is a smoker. Most, perhaps all experts feel that owners have the right to protect their properties against damages from smoking and to protect other occupants from secondhand smoke.

However, now the problem becomes one of detecting violators without running afoul of privacy rights. The solution is to both prohibit smoking inside of units; for multi-family properties,  on associated patios and balconies and within any common areas; and to make tenants responsible for damages resulting from failing to adhere to the prohibition.

This requires that applicants first be made aware that the unit is a non-smoking one in order to avoid wasted time and money in processing applications for those who might be unwilling to sign a lease that includes non-smoking provisions. Upfront notice can be accomplished in advertising, in an information sheet attached to the application form, and/or within the application form itself (the more places, the better).

The lease agreement should, of course, contain very specific clauses related to the non-smoking issue. In addition to a clear statement of the prohibition, acknowledged by the tenants upon signing the agreement, the lease should also
set out in some detail a list of damages resulting from smoking for which a violator will be responsible. The list would include items such as burns or stains on any component of the unit, odors, smoke residue on any surface, and
potential other liabilities such as damages resulting from smoking related fires. It should also include wording to the effect that these are examples of damages and not the only possible damages for which they will be liable.

The lease agreement should clearly make the tenant responsible for the cost of repairing, cleaning, painting, or replacing any items so damaged. Of course, the tenant must be initially provided with a unit that has no evidence of previous
smoking-related damage or such previous damage must be noted in the move-in checklist.

A landlord cannot introduce a non-smoking policy within units during the term of an existing lease, but can include it as a clause in any extension or renewal of an existing lease agreement. It would be best to give all tenants in a multi-unit
property advance notice that such will be the case. I won’t guarantee that prohibiting smoking within common areas or in other places (balconies & patios) where other tenants could be exposed to secondhand smoke would withstand a challenge by a smoker whose lease agreement does not prohibit it, but I wouldn’t be surprised if such a prohibition would be allowed because it protects the health of other tenants.

For multi-unit properties, prohibiting smoking inside units and in common area hallways and within some distance of residents’ patios, balconies, doors, etc, can actually reduce the risk of problems. Because tobacco smoke is often considered a nuisance in the same way that loud noise would be considered a nuisance, if tenants complain about drifting tobacco smoke landlords must take action to protect them.

In fact, landlords and property managers who fail to accommodate non-smoking tenants who complain about secondhand smoke may be exposing themselves to lawsuits. If a resident or prospective resident has a disability or chronic illness which is made worse by exposure to tobacco smoke, Fair Housing Laws will require a ”reasonable accommodation.”

Choosing a Tax Preparer

Hopefully, by this time of the year you know or are at least thinking about how your income tax returns will be prepared.  For most landlords there are basically two choices – do it themselves or hire a professional.

There are a number of reasons why a landlord might want to utilize professional tax return preparation rather than do it himself/herself. Reasons include:

• The landlord feels unqualified, perhaps because of some unusual current tax issue,
• The landlord prefers preparation by an expert with better knowledge and more experience,
• Using a preparer provides a buffer between the IRS and landlord and having a CPA’s signature on the return might even reduce the chances of an audit, or
• The landlord simply hates doing taxes.

There are several options for having your income tax return prepared if you don’t want to do it yourself. In order to choose a professional to prepare your tax returns, it is helpful to understand the different designations. They are as follows:

Certified Public Accountant (CPA)

To become a CPA, one must meet a state’s educational requirement, work for a specified period for another CPA, pass an exam administered by the American Institute of Certified Public Accountants, and have been issued a certificate of public accounting from the state Board of Accountancy.

CPAs are required to complete appropriate continuing education in order to be eligible to practice public accounting. In addition to offering bookkeeping, accounting, and auditing services, many CPAs also offer tax, business,
and investment advice. Furthermore, most large CPA firms have staff CPAs with extensive education experience in specific subject areas.

Enrolled Agent (EA)

These are federally licensed professionals who have passed a rigorous two-day exam or worked at least five years for the IRS. Although it’s possible that EAs are CPAs, they usually specialize in representing people before the IRS and seldom practice general accounting.

Tax Attorney (TA)

A tax attorney is a member of the bar who specializes in tax matters and usually has special training and experience in that area.

Tax Preparers

By this title we mean someone who has no professional designation after their name or a firm that has none on staff.

Only CPAs, EAs, and TAs are authorized to represent a taxpayer in all IRS-related matters, including audits, collection actions, and appeals. Therefore, if you use a department store or other tax preparer who is not one of these or
whose employer doesn’t have one of these on staff, you will have to hire one of these to help you in any future dispute.

There are many other tax preparers who are not CPAs, EAs, or TAs, but who are highly experienced and very competent. However, one should take extra care determining qualifications of such preparers, the easiest way being recommended by a trusted source who uses that preparer. Under this same category we put employees of the larger tax preparation firms, H&R Block being a well-known example, where there may be CPAs and/or other qualified personnel within the company, but where the undesignated preparer may be filing returns without oversight from above.

Most large chains provide training and continuing education for their preparers, as do most small firms who have been in business for at least several years. However, it is important that you have a good preparer, no matter which way you go.

Some preparation firms, particularly the large chains, have high employee turnover, which means you may not be able to use the same tax preparer every year. If developing a long-term relationship is important to you, seek out a
preparer with a lot of experience that has been in the community for some years.

Which Designation?

Few people need to routinely use a TA or EA except when fighting with the IRS or for some special esoteric tax advice matter beyond the expertise of a CPA. Furthermore, tax attorneys and enrolled agents do not usually offer the wide variety of services provided by CPAs. Accordingly, for the typical real landlord, a CPA is usually the best choice

If your tax return is fairly straightforward, even a CPA may provide more firepower than you need. Keep in mind that it is much better to hire more competence than you need rather then less, but, if you are certain that you don’t have a complicated situation and you really need to save a few dollars, you can consider using a competent tax preparer. This can be either one of the big chains, a small local firm, or a sole practitioner.
How to Choose the Professional

Do you choose a doctor or lawyer without checking the individual’s credentials? Hopefully, you don’t. Just as when choosing a doctor to perform critical surgery or a lawyer to defend you in a big lawsuit, you should use care in choosing a tax preparer.

Don’t just choose one at the mall while out buying shoes. Don’t fall for the line, used by preparers with desks at some of the big retail stores, claiming that you’ll get 25 percent off because you are that retailer’s customer. Ask yourself 25 percent
off of what? It’s almost certainly 25 percent off of a price list where everything’s been marked up by one-third (75% of 133.3…% of something equals the something) or worse.

Don’t choose the one with the biggest ad in the Yellow Pages. The best professionals, including tax preparers, get most of their new business from referrals from satisfied existing clients.

The best way to select a tax preparer is the same as the best way to select a dentist, lawyer, or real estate agent; by having personal knowledge of the individual and of their abilities and experience. The next best way is to get a referral from a
trusted acquaintance who has personal knowledge. If neither approach is possible, be sure to check credentials with the appropriate licensing agency or with relevant professional organizations.

The worst way to choose a preparer would be to choose one at random from the Yellow Pages or by the size of the ad. Professionals make their money by whom and what they know, not by an ostentatious advertising.

Caution

Unfortunately, strong demand for tax preparation also has attracted some questionable preparers. Some are only incompetent, overlooking deductions and credits that could lower your tax bill or taking improper deductions that might
result in penalties. Others are crooks who manufacture phony expenses in an effort to pump up your refund, resulting in potential taxpayer liability for penalties or even possible IRS accusations of fraud.

Fortunately, the bad guys aren’t usually very creative. Habits of dishonest tax preparers, no matter what their designation, who should be avoided include:

• Guaranteeing a refund, or promise to deliver a bigger refund than the competition.
• Refusing to discuss the fee in advance. Although the exact amount may not be certain for complicated returns, they should at least explain exactly how the fee is calculated.
• Charging a fee based on a percentage of your refund, most likely resulting in illegally increased refunds to increase their profits.
• Requesting you to sign a blank return so that the preparer can insert false information or divert your refund to his own account.
• Encouraging you to provide information you know isn’t true, e.g., fictitious charitable deductions, casualty losses, medical expenses, or business expenses.
• Suggesting that they know of a legal loophole that will allow you to evade paying income taxes. The IRS has aggressively pursued preparers who promote these scams.
• Refusing to sign your return as being the preparer and, as required beginning this year when a fee is paid, failing to provide an EIN.
• Using tax preparation as a pretext to sell other costly products and services, such as high-interest refund anticipation loan and/or other products or services.

Taxpayers are always responsible for information on their tax returns, even if it was prepared by someone else. If the IRS determines that a return contains fraudulent information, the individual will be liable for the unpaid taxes, not the preparer. It is even possible that both will go to jail. To this will be added interest and penalties assessed by the IRS and state taxing agency, maybe even significant costs for a CPA and/or an attorney.

Even when no fraud is involved, but additional taxes are assessed due to “honest” errors, taxpayers will be liable for penalties and may even have to pay another preparer to straighten things out if the original preparer is no longer around.

Do You Have Possession?

Whether the tenant left at the end of his lease term, terminated his lease early upon mutual agreement, or left in the midst of his lease term without even telling you, the fact is you have a vacancy. However, what you can or should do next can depend on how the vacancy occurred as well as what might have been left behind.

There are a number of potential issues regarding landlord possession of a rental unit and landlords do not always consider the ramifications of assuming that the tenant has returned possession when that was not the tenant’s intent.

There are also issues regarding tenant personal property still on the premises after it appears that the tenant has moved out.
What a landlord can do or must do when there is any question regarding the tenant’s intent to vacate varies significantly among states. Accordingly, while we will in this article provide discussions about some of the issues, landlords must research and understand the laws of their particular states.

Who Is In Possession?

The landlord should consider the issue of possession whenever there is any question as to whether or not the tenant has truly vacated the premises, that is, he intended to relinquish possession back to the landlord.

This is especially a problem when a tenant appears to have abandoned the unit without any notice, but has left some belongings behind. The problem is knowing whether the tenant has permanently left and intended to leave the belongings for
disposal by the landlord or, instead, plans to return at a later date to retrieve the belongings, even to re-occupy the unit because the tenant did not intend to relinquish possession of the premises. This can still be an issue even though the tenant is not current with rent because the right of possession exists independent of paying rent unless a court ordered eviction has been completed.

Accordingly, a landlord should not take possession of the leased premises unless and until he/she is sure that the tenant intended to relinquish possession of the premises.  Doing so otherwise can expose the landlord to various potential problems.

Following proper procedures causes delays of a few days, even a couple of weeks, and delays in collecting rent from a new tenant means lost income. However, failure to follow the laws of your state can result in problems, even result in being sued by the departing tenant. Accordingly, before worrying about what to do regarding filling a vacancy, you need to be sure that you have legal possession of the unit. That is, you need to be sure that the old tenants have no possession rights. In some states, one must even use care in entering the unit when not certain as to the tenant’s intent and plans.
The question of whether the tenant has actually given up possession usually becomes an issue when the tenant appears to either (1) be holding over after the expiration or termination of a lease or (2) to have abandoned the premises in the midst of the lease term.

In the first case, extra caution is warranted if the tenant has not (1) turned in keys, (2) written or at least phoned to confirm vacating or a planned immediate departure, (3) given any other indication of certain vacating, or (4) removed all
belongings from the property without mentioning that he intended to leave the items for disposal by the landlord.

In the second case, the tenant appears to be no longer living at the property even though time remains on the lease, perhaps even time for which rent has been paid, and some of his/her personal property may remain on the premises.

Statutory Possession

When a landlord is considering whether or not he/she has gained legal possession of a rental unit, he/she must be aware of any specific requirements in the statutes of his state. Such possible requirements vary significantly among those states which have them.

For example, a state may specify that the landlord does not have possession absent a specific action such as the keys being turned in. Absent such an action, state law may require that the landlord perform “abandonment” procedures or commence a forcible detainer action (eviction).

An “abandonment” procedure typically requires that rent has not been paid for at least some period after it was due (e.g., 10 days) and the landlord had been unable to contact the tenant for some period (e.g., 7 days). The landlord can then (and only then) post an abandonment notice on the door stating that he/she will be taking possession of the unit at some date (e.g., 5 days later). All periods must be as specified by the statute of the particular state. Although such a
statute significantly delays getting the unit ready for a new tenant, failure to follow the statute can put a landlord at risk.

Of course, any personal property left on the premises must be dealt with as required by the state’s abandoned property laws, as discussed later.

Minimizing Possession Issues

Minimizing questionable vacancy issues begins with the lease agreement. Absent any statute prohibiting it, the lease agreement should contain a clause(s) that specifies the length of time that the tenant may leave the property without prior notice to the landlord (e.g., 7 or 10 days ) and provides that the unit may be considered abandoned if such notice was not provided. The clause should meet any statute requirements that might exist.

One must, of course, take great care when utilizing such a clause because there could be a lot of reasons why a tenant failed to give the required notice. For example, the tenant is in the hospital ICU following a heart attack or an auto accident.
Accordingly, a landlord must make some effort to track down the tenant or information regarding the tenant. Efforts might include calling the tenant at his place of employment and/or the emergency contact and/or any personal references that should have been provided with his application.

The lease should also contain a clause(s) regarding procedures for vacating and what actions might be taken by the landlord if procedures are not followed, including any required by statute. That is, words as to what the tenant must do
when vacating and what will happen if the tenant fails to act as agreed.

For example, in order to provide definitive knowledge of when possession has transferred, a clause could state that all belongings must be removed and keys must be returned when the tenant has fully vacated and that failure to do both will result in (1) continued accrual of rent and any relevant late charges, (2) charges for the costs of disposing of the abandoned belongings, and (3) a locksmith charge.

Some states have statutes that define how a landlord may proceed to recover possession when the tenant appears to have abandoned the premises. When your state defines such procedures, the lease agreement should include the procedures as defined in the statute.

Certainty about vacancy can also be enhanced by regularly monitoring the property beginning a short time before the tenant is expected to be vacating. It can be useful to stop in when it appears that the tenant has nearly finished loading the truck. At this time, you can confirm intent, mention the need to return the keys, and remind the tenant of the lease clauses and the penalties for failing to follow the procedures. If possible, have the tenant’s lease agreement with you when doing this. Furthermore, if possible, a signed written agreement listing what is being left behind and stating that the tenant understands that he will be charged for disposal would be very useful. At a minimum the landlord should write a memorandum regarding the visit and the discussions.

Sometimes a landlord has information to indicate that tenants are leaving well before the end of a lease – i.e., breaking the lease.  Either the landlord has been monitoring the property and has noticed evidence of a planned move or another tenant or an adjacent property owner or tenant has voiced suspicions or actual knowledge of the possible departure to the landlord.

In this case, immediately talk with the tenants and make sure that they understand the implications of breaking the lease and the potential impact on their ability to rent or buy a home in the future. Consider negotiating mutually acceptable terms of lease termination. It is better to obtain quick and clean possession rather than have disputes after the fact even if you must give up some rent. If the tenant is leaving before the end of the period for which rent has been paid, doing this can provide a head start on preparing the unit for a new tenant. The negotiated terms should be in writing and include clauses regarding paid rent, possible forfeiture of some or all of the security deposit, and abandoned items.

Question 1

Can I make the tenants responsible for all maintenance on my rental units?

Answer 1

Depending on the law of your particular state, the type of rental property, and/or the reason why a particular type of maintenance is needed you may be able to make the tenant responsible for all, for some, or for no maintenance expenses.

In many states the landlord is made responsible by statute and/or under habitability standards to bear the costs of most maintenance for residential rentals. There are limited exceptions to this basic statement.

First, most states allow the tenant to accept responsibility for maintenance in a single-family rental home.

Second, tenants can usually be held liable for the cost of repairs that are required because of their actions or negligence. However, there can be issues when the tenant is to blame for damage that would make the unit uninhabitable under federal, state, or local laws and the tenant is unwilling or claims to be financially unable to cover the cost. For example, refusal to repair a heating unit in winter or a water heater anytime even if the problem is the fault of the tenant could result in the landlord suffering significant penalties for not making the repair. At a minimum, a tenant may have the right to break the lease and move, potentially resulting in a significantly larger financial loss due to vacancy and rehab costs compared to the landlord simply paying for the repair.

Even when state law allows making the tenant responsible for repairs, it is prudent to significantly limit the items for which the tenant is responsible. The reason is that the pool potential of applicants will likely be greatly reduced in either size or quality, or most likely both when the tenant is at risk for large expenses. For example, if applicants know in advance that the lease will make them fully responsible for major items, such as heating/cooling systems or appliances or plumbing systems, it will almost certainly mean that the only applicants will be those who would likely simply walk away upon occurrence of a major problem. Those who could afford such costs might rather pay a fixed amount of higher rent for a better
rental.

Well qualified applicants would be foolish to sign a lease that could leave them liable for repair or replacement of major appliances, a furnace, or serious plumbing system problems when they would likely have no idea of the age and condition of such items at the time they sign the lease and would unlikely be interested in paying hundreds of dollars for a home inspection ahead of time. Failure to notify potential applicants about the extent of their maintenance responsibilities at the time when they obtain an application form can result in wasted time an effort because after completing screening of applicants and notifying the winner and all losers regarding your selection, the winning applicant may refuse to sign the lease,
requiring that the landlord start over trying to fill the vacancy.

Accordingly, when maintenance responsibilities can be transferred to tenants, both legally and practically, they should be limited to minor issues, preferably those which are very low cost and for which the tenants can handle the labor themselves. However, even then, it can sometimes create problems for the landlord.

For example, tenants are often made responsible for repairs costing up to $50 or $75. For example, sometimes the responsibility is limited to fixing leaky faucets. However, a tenant may be willing to live with a leaky faucet rather than spend the money and time to correct the problem and leaky faucets can result in damage to cabinets and/or flooring that will be expensive to correct. Trying to collect for the damages caused by the tenant’s failure to properly maintain will at least be difficult and might be impossible even after costly legal action.

The bottom line is that it is usually better for the landlord to retain responsibility for maintenance and charge higher rent.

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Question 2

I want to sell my rental house. It is currently occupied by 4 tenants with a 1 year lease ending about 6 months from now. What are the steps in notifying the tenants about the sale and showing of the home while occupied?

Answer 2

First, the existing lease agreement is valid and enforceable until its expiration date and the lease binds the buyer if sold before its expiration.

Second, most lease agreements and the laws of many states require tenants to cooperate with any agents of the owner including real estate agents, appraisers, contractors, etc. However, entry to the property must be preceded by the required advance notice. The minimum period is 24 to 48 hours in most states, but this would be overridden by any longer period specified in the lease or by any lesser period if state law allows tenants to waive a longer law requirement. However, the
entry time must be at reasonable hours. If a tenant refuses to cooperate, entry cannot be made and the only recourse would be to file a lawsuit.

Due to possible problems with access and the fact that the property may not show well when occupied by tenants, it is usually best to not try to sell a single-family property while leased.

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Question 3

I am a new landlord and the lease term for one of my rental units is nearing completion. Do I need to serve the tenant with a notice to quit the lease?

Answer 3

What you need to do to terminate the lease depends on the clauses in your lease agreement and, in a few states, the law.  It can be of benefit that the lease agreement explicitly discusses end-of-lease issues. For example, the agreement may state that the tenant is expected to vacate the unit if an extension or renewal agreement has not been executed by the parties at least some number of days (typically 30) before the ending of the existing lease term. As another example, the agreement may state that the lease becomes a month-to-month lease if no action has been taken regarding an extension or renewal, the landlord has not given notice of termination, and the tenant holds over beyond the term end – often with an increased rent amount.  This latter clause is almost always included in a lease agreement.

It never hurts to provide a termination notice prior to term end no matter what the lease requires when the landlord desires to have the tenant depart rather than renew or extend the lease. The tenant can be notified that you do not wish to extend his tenancy beyond the term of his existing lease by providing a written notice that clearly states that fact.  No reason need be given and it is best to not give a reason that can in any way be considered a violation of fair housing laws. Such a notice can be given at any time prior to term end unless otherwise required by the lease agreement or law, but it should be long enough in advance for the tenant to make plans.

Income Verification

Verifying that the applicant has adequate income with which to pay rent is near the top of the list of screening items for many landlords. There are many sources of income with wage earnings being the most common. Other possible sources of income include self employment, stocks and bonds, trust funds, mutual funds, spousal or child support, government assistance, and income from rental properties.

In recent years it has become ever more difficult to get employment information from employers because of the fear of lawsuits. Some employers will not even admit over the phone to knowing their own employee. Others will not give out any information without written authorization from the employee and will only respond to a written request, sometimes requiring that it be on the employer’s own form. Employers may be unwilling to respond via phone, fax, or email.

The best approach is to have a separate and specific release form for employment verification (dates of employment and wage amounts) signed by the applicant employee and mailed or faxed by the landlord to the appropriate employment department, with verification that it is valid destination.

It is, of course, important that the form be returned directly from the employer rather than passing through the hands of the applicant if possible. If it does pass through the applicant’s hands, you will need to verify the legitimacy of the returned form.

When one runs into such obstacles to obtaining employment information one option is to leave the burden of verification up to the applicant and only require that the employer mail it or fax it to you or that the applicant authorize the employer to respond to your phone call to a phone number which can be verified as legitimate.

As a landlord, you want to determine whether or not the applicant has sufficient income to afford the rental property, but this can usually be accomplished by means other than verification by employers.  In general, a landlord can request whatever financial information is desired in order to confirm the applicant’s ability to pay under whatever legal, reasonable, and logical criteria the landlord uses, so long as the same requirements are demanded of all applicants.
In view of the ease with which any document can be produced on home computers, one must always be concerned about authenticity of any documents provided by applicants themselves.

Employment and income documentation should consist of requiring the applicant to produce the last several paycheck stubs. Relying on the most recent year’s W-2 provides no certain information regarding current income since a W-2 is always old information and provides no proof that the applicant has had a job during recent months, although it can be useful as additional verification if authenticity of other items is questionable.

Pay stubs are useful for confirming current employment and amount of income, if not otherwise confirmed, and sometimes even to verify the applicant’s Social Security number. However, considering the ease of generating any counterfeit document on a personal computer, pay stubs should not be the sole documentation. In any event, review the pay stubs to verify that the applicant’s name, address and Social Security number are the same as shown on the application and, if not, determine the reason for the fact. The pay stub may also show the pay period, monthly, bi-weekly, or weekly. Make copies of the stubs and/or any other documentation utilized.

Self employed individuals can be asked to provide copies of their tax returns, preferably at least two years worth, to reduce the impact of a business that has large swings in annual income. Last year’s Form 1099s mean little, as it is net profit shown on the Schedule C rather than gross revenues that counts when judging whether or not the applicant can afford the rent, except, again, that they can be useful for verification of gross income. However, you must remember that
self-employed individuals often do not receive Form1099s for all gross income and, in fact the amount of income provable by 1099s can be very low. The percentage of gross income represented by 1099s varies with type of business
whether the clients/customers are aware of and follow IRS rules related to reporting payments with 1099s. In other words, the total of Form 1099s is a minimum gross income and may be substantially less than actual gross income.
Finally, gross income may be indicative of an applicant’s ability to pay rent or may mean nothing.

Also keep in mind that the most recent tax return will usually not be providing current information, as depending on the time of year, possibly as much as about 15 months old. However, as mentioned earlier, the bigger problem is that, with
today’s computer software, it is possible to generate a tax return within minutes that is in no related to the one filed with the IRS. Accordingly, for applicants whose tax returns are prepared by a CPA or other professional preparer, it if best to require that the preparer provide the tax returns and that you have the right to speak with the preparer after receiving the returns.

It is possible to obtain a copy of an applicant’s Form 1040, as well as attached forms and schedules, directly from the IRS with the permission of the applicant. However, considering the time required to do so, typical screening and selection process time would not usually allow doing so. Additionally, the cost of the copies, particularly if multiple forms and schedules are necessary, may be prohibitive.

Although wage earnings is probably the most common source of income, with self-employment income perhaps being next, there are numerous other possible sources of income. Other sources include interest, income from stocks and bonds or mutual funds and other investment vehicles, regular payments from trust funds, spousal or child support, disability payments, government assistance, retirement programs, retirement income including Social Security and both private and government pensions, and income from rental properties.

If another source of income will be used for rent payment, verifiable documents, appropriate to the source of income, should be requested. Verification of such income must be considered on a case-by-case basis. Most non-earned income is relatively easily verified because the recipients are provided statements showing the amounts, although, again, verification of validity must be considered.

Your procedures can also address the issue of cash-only workers. Cash income presents problems because most cash employers will be unwilling to furnish documentation of employment and cash payments. If a cash-only worker thinks he/she can provide adequate documentation of income and the likelihood of steady future income, you may wish to accept an application. While you cannot arbitrarily discriminate, you can enforce your policy requirement of legitimate, adequate documentation of source of funds for rental payments.

When possible, it is usually best to consider multiple documents that together confirm what the applicant puts on the application form. Documentation related to verifying income should be copied and retained because it might be useful in case of the need to collect a judgment later obtained against the tenant. However, as for all personal information regarding applicants and tenants, care must be taken to safeguard the information while retained and documentation must be properly disposed of when no longer of possible value.

Finally, keep in mind that a good credit record, absence of an eviction record or a relevant criminal record, and a satisfactory report from previous landlords are usually more important than the details of employment. Many tenants pay their rent on time and take good care of rental property with very minimal income, while many others fail to pay rent and/or trash properties in spite of substantial incomes.

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Question 1

Are there any reasons why I might not want to have Section 8 tenants?

Answer 1

Section 8 has both advantages and disadvantages. The main theoretical advantage is that the government guarantees the rent. However, in practice there are many ways in which this can become untrue. For example, if the tenant originally qualifies for 100 percent subsidy and a couple of months later the tenant qualifies for only 20 percent subsidy due to a change in financial circumstances (e.g., found a job), the landlord must depend upon the tenant for 80 percent. Furthermore, rent increases are limited and require permission of the housing agency and if the market rent (FMR) goes down, the rent you’ll receive is reduced. There are circumstances where the landlord may not receive payments for certain periods of time.

You also have the same problems regarding unpaid rent and damages that you have with any other tenant because the government is not responsible for the tenant’s share of rent or what the tenant does to your property. In fact, you are less likely to collect for unpaid rent and damages beyond the amount of the security deposit than for non-Section 8 tenants because the typical Section 8 tenant has less to go after.

The most basic disadvantage of the program is that the government gets more control of your business. There is an initial inspection, annual inspections, and inspections if the tenant complains about something. Section 8 standards are often higher than habitability laws and/or what the landlord must usually do in order to attract good tenants for the particular property.

If the tenant must be evicted it is the landlord’s problem and there will be little or no help from the agency that administers Section 8. In fact, they may terminate payments upon commencement of the eviction.

Be sure you understand the program before you get involved with Section 8 and, if you do, be sure that you select tenants using the same screening and selection standards as you would for an applicant who is not Section 8, only taking into account that Section 8 will initially be paying part of the rent.

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Question 2

I want to sell my rental house. It is currently occupied by 4 tenants with a 1 year lease ending about 6 months from now. What are the steps in notifying the tenants about the sale and showing of the home while occupied?

Answer 2

First, the existing lease agreement is valid and enforceable until its expiration date and the l lease binds the buyer if sold before its expiration.

Second, most lease agreements and the laws of many states require tenants to cooperate with any agents of the owner including real estate agents, appraisers, contractors, etc.  However, entry to the property must be preceded by a notice period as required in the lease agreement or by state law, whichever is greater unless state law allows for a lesser time being specified in the lease. The minimum period is 24 to 48 hours in most states, but this would be overridden by any longer period specified in the lease. However, the entry time must be at reasonable hours. If a tenant refuses to cooperate, entry cannot be made and the only recourse would be to file a lawsuit.

Due to possible problems with access and the fact that the property may not show well when occupied by tenants, it is usually best to not try to sell a property while leased.

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Question 3

I am soon closing escrow on purchase of a 20-unit apartment building. State law requires that I have a resident manager.  Is there any reason why a resident manager must be licensed? Is it true that this person must be an employee rather than treated as an independent contractor?  What is the best way to handle compensation?
Answer 3

To my knowledge no state requires that a resident manager need be licensed. It is important that a resident manager be adequately qualified regarding knowledge related to all management issues, including procedures and laws. Of special concern is adequate knowledge regarding federal, state, and local fair housing laws. Accordingly, someone with a real estate license might be expected to have knowledge of such laws.

A resident manager must be classified as an employee for a number of reasons. A primary reason is that the owner or property manager must provide close supervision of the resident manager. An owner almost certainly won’t be giving him/her authority to decide what rents or deposits to charge or what days and hours to work or where to accomplish the work. Ann owner must be absolutely sure that he/she obeys the numerous laws affecting income property including landlord-tenant laws, fair housing laws, lead paint disclosure laws, etc.

Owners must be concerned about everything the manager might do as the owner’s agent and how the manager accomplishes those tasks. One cannot only care about the end result – low vacancy rate and 100 percent of rents collected – because there are many ways to accomplish these end results that would violate a lot of laws (e.g., fair housing) as well as open the owner up to other civil litigation, perhaps even to criminal prosecution. Thus, owners should establish very specific written management procedures.

The penalties for categorizing an employee as an IC can be quite substantial and can come from the IRS, state and local taxing agencies, the state worker’s compensation board, or an owner’s own insurance company.

Compensation of a resident manager depends greatly on a number of factors including the quality of the project, the size of the project, the duties and responsibilities of the manager, and the qualifications of the manager.

Usually, compensation of a resident manager includes a rent-free or reduced-rent apartment unit. The reason for this is that there are tax benefits to both the employer and employee compared to all compensation being in the form of paychecks.

The value of any living space provided the manager without charge or at a reduced rent must also be taken into account when calculating withholding and other payroll tax items for federal, state, and local levels of income taxation. However, landlords and resident managers do not have to pay FICA taxes on the value of free or discounted rent if all of the following conditions are met:

• The resident manager’s unit is on the rental premises and
• The landlord provides the unit for the landlord’s convenience (or to comply with state law) and
• The resident manager accepts the unit as a condition of employment. That is, the manager is required by the landlord to live in the unit in order to be the manager.

The value of the reduced rent will be considered regarding minimum wage and overtime issues.

In addition to or instead of a free or reduced rent unit, additional compensation might be provided via fixed salary, hourly wages, bonuses, and/or commission,

Fixed Salary – A fixed weekly or other period salary can be a good way to handle compensation as long as one retains a way to determine what and when work is getting done and ensure that minimum wage and overtime laws are not violated. This means that one must require the manager to maintain a timesheet and adhere to the maximum hours allowed each week considering the compensation.

The main advantage to the resident manager of a fixed salary is that the resident manager knows exactly the amount of the next paycheck. This is a disadvantage to the owner if the work load varies significantly from month-to-month, for example, in areas where there are significant seasonal variations in vacancies.

Hourly Wages – Since owners should require the manager to maintain time sheets, anyway, there is no administrative reason to not pay by the hour. However, there are two issues that must be taken into consideration.

First, at the one extreme, one doesn’t want the manager making work in order to increase his/her paycheck, so there must be a maximum number of hours per pay period. Second, at the other extreme, most managers probably want and need to know that they will have a minimum income each month, so one also needs to also provide a minimum number of hours of tasks per month.

Bonuses & Commissions – When compensating resident managers, some owners like to provide additional incentive to their resident managers by paying bonuses or commissions related to maintaining high occupancy rates and/or low vacancy and/or turnover rates. There are two potential problems with doing this.

First, laws and regulations of some states prohibit payment of such fees and commissions to unlicensed persons. Some states do make exceptions for nominal payments to resident managers. Owners must determine whether their state deals with this issue and, if so, follow the law.

Second, there is the possibility that rewarding the manager for minimizing vacancy might result in lowering of standards, particularly in a bad rental market. This would be of most concern when the resident manager is allowed to select tenants and would be of much less concern when screening and selection are not performed by the manager.

Landlords should always utilize a written employment contract as well as a written lease agreement for resident managers.  Although oral agreements can be legal and binding, it can be difficult, even impossible to prove what the terms of an agreement were if there is a future dispute about the terms.

Owner’s should not promise or even imply long-term job security or otherwise give assurances about the length of employment or tenancy. The employment contract should make clear that it is an “at will” employment situation and emphasize the right to fire an employee at any time and for any reason not prohibited by law. Similarly, the employee may quit at any time, for any reasons, and with or without notice.

Many attorneys recommend that they be separate agreements rather than a single combined one. If separate documents are utilized it is important that each agreement be adequately tied to the other and that each provides for the termination of occupancy with termination of employment issue and vice versa. Remember that the person cannot serve as manager if not a resident.

It may be possible in some states to terminate the tenancy of a resident manager upon termination of employment without the normal tenant notice requirements, but other states give the resident manager the same rights as any other tenant, that is, stay until the end of the term of the lease even after termination of employment. Being sure that the manager is a month-to-month tenant will minimize the problem. It may be possible to expedite departure with a reasonable cash payment, but be sure that this is done carefully. Whatever the law of the state where the property is located, if the manager refuses to leave voluntarily the owner will have to evict in order to recover possession of the manager unit.

Much more information regarding resident manager issues can be found in our Mini Training Guide titled “9 Resident Manager Issues.”

Existing tenants in rental property that is being considered for purchase can be either assets or liabilities.

The most obvious benefit is having no rent-up time for any units that are currently leased. A related secondary benefit is that obtaining financing may be easier because the lender knows what the true rental income is for the property rather than having to depend on the borrower’s projections, possibly overly optimistic, or do extensive market research of its own.

However, inheriting existing tenants can also mean more risks unless the buyer takes adequate steps to know exactly what he/she is getting. In this short article we’ll briefly discuss a few of the issues.

Some potential risks are minimized by (1) actions prior to making an offer, (2) writing a good purchase offer contract, (3) adequately analyzing accounting records and lease documentation during the due diligence period, (4) verifying the condition of unit interiors as early as possible, and (5) corresponding with the tenants immediately following close of escrow.  We will discuss these items only as they relate to the existing tenants.

Pre-Offer Tasks

If possible, require certain written information prior to even writing a purchase contract. In addition to knowing the current rents and the lengths of existing leases, this should include knowing the terms of any options for extensions or renewals because when rents can be increased, tenancies terminate, and introduction of the buyer’s own lease agreement can be important to current value and future operations. It is particularly important to know such information for
commercial properties before deciding on the price to offer, because multi-year options are almost always part of commercial lease agreements, while only occasionally seen in residential agreements.

Writing a Good Purchase Contract

In general, the most important issues related to a good purchase contract is that it contain requests for copies of all relevant documentation and adequate contingency clauses related to all issues that are material factors in a buyer’s decision of whether to own the property for the price that will be offered.

Regarding existing tenants, the most important documentation includes lease agreements; Rules & Regulations or other policy statements issued by the seller to tenants; rent payment histories; and application forms, screening reports, and move-in checklists. If the property currently has a resident manager, the employment contract and associated lease agreement as well as instructions and policy statements related to management should be requested. It should also require copies of leases and related documents and verify that leases agree with information previously provided and contain adequate legal clauses and no illegal ones.

It is recommended that there be contingency related to inspection of units early in the due diligence period, not only to determine general interior physical conditions, but to also ascertain that there are not damages that could not be reimbursed from existing security deposits – hence the need for move-in checklists.

The offer should require that the seller confirm that there are no lawsuits, regulatory agency actions, or other claims pending against the property related to previous or current tenants not previously disclosed in writing and require a warranty that the seller has complied with federal and state lead laws and other potential contaminants. It should require that the seller provide copies of required disclosure documents for existing tenants under federal, state, and local laws and any
inspection reports related to possible contaminants. The contract should require that the seller provide copies of documentation related to complaints by other tenants, neighbors, and government agencies about any tenant.

Avoid potential after-closing problems by utilizing Estoppel Certificates and making execution by all tenants a contingency. Although often not utilized unless required by the lender, as they usually are for larger properties, Estoppel Certificates should be used for every purchase of a tenant occupied property. An Estoppel Certificate is a document signed by a tenant that, among other things (1) affirms the lease documents (attached to Certificate) and the deposit/rent amounts; (2) confirms that there are no agreements outside of the attached documents; and (3) confirms the amount of security deposit, the current rent, and the date to which rent has been paid. The document is sometimes called a Certificate
of No Defense. In addition to verifying information provided by the seller, the Estoppel Certificate “stops” the tenant from making claims regarding the included issues after close of escrow.

If closing is delayed, it might be necessary to get updated amendments to the certificates to cover rents collected since the previous versions were executed or because of certain other special changes in circumstances, including amended or new leases.

Although the buyer would theoretically have legal recourse against the seller if he/she had been provided false information or not been provided “material” information, doing anything about it might take years. It might even be impossible, for example if the seller moved to Switzerland immediately after closing escrow.

Escrow Issues

Since the buyer will be responsible for returning all or part of security deposits when the existing tenants leave, the purchase offer contract (and any subsequent escrow instructions) should explicitly state that the buyer is to be credited with security deposits at closing. The seller should also be required to provide a signed letter at close of escrow informing the tenants that the property has been sold to the named buyer.

After Closing

A buyer should correspond with the tenants immediately following close of escrow. A copy of the letter from seller mentioned above should be attached to a letter from the buyer. The buyer’s letter should confirm being the buyer, instruct the tenants where to pay their next rent and how to contact the new landlord, inform them that he/she and/or his/her vendor will be making a detailed inspection in the near future (with reasonable notice) to check for maintenance problems, and request them to report any problems of which they are aware. If the previous owner utilized Rules & Regulations and the buyer wishes to change them as would be allowed under the lease agreements and general lease agreement legal principles, the new Rules & Regulations could also be included. The new landlord can also affirm that he/she is a “Fair Housing” landlord.