Question

I know I must have smoke detectors in my rental units. Do I also need carbon monoxide detectors?

Answer

As for smoke detectors, requirements regarding carbon monoxide detectors may depend on what state or county, even what municipality your units are located in.

In review, carbon monoxide (CO) is a colorless, odorless gas potentially generated by any fossil-fuel (most commonly oil, gas, coal, or wood) burning device, including furnaces, kitchen ranges, water heaters, and clothes dryers. CO is a product of incomplete combustion of the fuel, so it is also a product in most fires.

Fossil fuel burning devices that are not well-maintained are particularly dangerous. Inadequate venting for the devices is another source of danger. Since gasoline engines also generate CO, attached garages are also a potential source of danger.

Although not all jurisdictions require CO detectors by law, the number doing so has been increasing in recent years and will almost certainly continue to increase in the future. Even when not required by law, landlords will be exposed to significant liability if an inadequately vented or improperly maintained device results in injury or death to tenants.

Since detectors can be purchased for as little as $15 each, the prudent landlord will provide them for all units having fossil-fuel burning devices or attached garages. The detectors will go a long way toward preventing serious injury or death and staying out of court. Installation should be in accordance with the manufacturer’s instructions in whatever locations as might be required by law.

Inspection of fossil-fuel devices at least once a year is highly recommended, with all necessary adjustments and repairs made immediately. In many areas, the local gas company will inspect gas appliances for free. Even if the landlord must pay for inspection by a qualified professional, the cost will be negligible compared to the judgment that might be handed down by a jury if someone is seriously injured or killed due to failure to properly maintain the devices. As a minimum, for battery-operated units landlords should themselves replace batteries once a year or at such lesser interval as recommended by the manufacturer or required by law.

When Landlords Buy Tenant Occupied Properties.

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 the 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 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 lager 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.

Lease Agreements Between Landlords and Tenants – Part 6

In Part 5 of our Lease Agreements series we discussed the issue of specific clauses being required by some states.  In this article we’ll briefly discuss several issues regarding lease changes.

Modifications

There are a variety of circumstances when a lease agreement must be amended.  Reasons for amendments include the following:

• Renewal or extension of lease, with or without a rent increase or other changes.
• Adding a pet.
• Adding or deleting co-tenant occupants.
• Bringing in water-filled furniture.
• Replacing the original tenant by another to finish out the term of a lease.

Although it is legally acceptable to mark up the existing documents, with both parties initialing the changes, it usually best to not take this approach.  While some modifications can be made by using an amendment document (e.g., an extension of term without other changes), others should be accomplished by writing a new lease agreement (e.g., adding a co-tenant).  For a month-to-month tenancy, modifications can, in most jurisdictions, legally be done by providing proper notice to the tenant and the tenant’s signature is not required.

When replacing a lease agreement that hasn’t yet expired with a new one because of significant changes in terms, it is a good idea to write “Cancelled by mutual agreement and replaced with new document” on the front of the old one following execution of the new one by all parties, with both landlord and tenants (should be all adult occupants) signing and dating the statement.  You should also be sure that there is not an overlap or a gap between the cancellations date and the effective date of the new lease.

The subject of subleasing and assignment of leases should also be covered in lease clauses.  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 and require that the replacement tenants meet all screening criteria.

Sublease

An individual who rents all or part of a rental unit from a tenant and does not sign a lease with the landlord becomes a sub-tenant.  The individual rents or sublets the entire unit from a tenant who moves out temporarily or he rents or sublets a room or rooms from a tenant who continues to occupy the unit.  Oftentimes the original tenant moves out for the summer, semester, sabbatical leave, or temporary change in work location.  The arrangement is made by the tenant and the sub-tenant and is contingent upon the sub-tenant moving out when the original tenant returns.

Subleasing is usually prohibited by a lease agreement, although the agreement may provide for subleasing with permission of the landlord.  However, some states may not allow outright prohibition, requiring a legitmate business reason (e.g., bad rental history of the prospective subtenant).

Some states have statutes prohibiting subleasing without permission of the landlord even if not so stated in the lease agreement.  Other states do not address the issue and leave the decision to sublease to the landlord.  There are also limitations in some states regarding the type of lawsuits that may be filed by landlords against sub-tenants.  In some states the landlord and the sub-tenant may file suite against one another to correct behavior in violantion of the lease but they may not sue for money damages.  For example the sub-tenant could sue for violation of habitable premises,  but the landlord could not sue the sub-tenant for excessive property damage not covered by the security deposit.  In such a case, to recover his loss, the landlord would need to sue the original tenant.

The primary relationship between the landlord and tenant is retained with the tenant still having control over the rental unit either because he occupies part of the unit or he reserves the right to regain possession of the rental unit at a later date.

The original tenant becomes the sub-tenant’s landlord.  The sub-tenant pays rent to the tenant at whatever amount they mutually agreed to.  The original tenant is responsible to landlord for the rent per the master lease agreement.  The oral or written arrangement between the tenant and the sub-tenant is known as a sublease.

The landlord is cautioned to not accept rent from a sub-tenant.  If the landlord treats the sub-tenant as if he were a tenant by taking rent or acting in some manner towards the sub-tenant that would indicate his status as a tenant, the landlord by his actions might in effect relieve the tenant of his responsibility by creating a tenancy from a sub-tenancy.

There are situations where a sub-tenancy might be of benefit to the landlord.  If the original tenant was considered a model tenant with an excellent rental history with the landlord and the landlord is willing to take the risk that the original tenant will return to occupy the unit, the landlord probably does not risk a great deal.

Assignment

When the original tenant permanently turns over his lease to a new tenant, he has completed an assignment of the lease.  The original tenant, the assignor, moves out of the assignee moves in.  An assignee can sue or be sued by the landlord.

From several standpoints, the landlord should usually prefer an assignment of lease to allowing a sublease.  An assignment provides more landlord control over the tenant because the landlord has a direct legal relationship with the assignee.  Furthermore, it is usually possible to require that the assignor remain liable on the lease upon default of the assignee if the landlord so desires.  Assignors will usually agree to such liability because assignment is almost always due to financial difficulties and the assignors would likely have even  greater liabilities if they simply broke the lease.

Similar to subleasing, assignment is usually prohibited by a lease agreement,  although the agreement may provide for assignment with permission of the landlord.  However, some states may not allow outright prohibition, requiring a legitimate  business reason (e.g., bad screening reports regarding the prospective assignee).

As for subletting, some states may have statutes prohibiting assignment without permission of the landlord even if not so stated in the lease agreement.  In general, the landlord and the assignee are bound by the terms and conditions of the lease signed by the assignor except as modified by agreements of all parties.  The original security deposit is usually retained by the landlord, with adjustments made between assignor and assignee.  Accordingly, any refund of security deposit money will go to the assignee.

It is recommended that a formal document regarding assignment of lease be signed by all parties to the original lease and, if multiple assignees, by all of them.  In addition to other clauses in the assignment, unless the landlord agrees otherwise, the document should state that the assignor is still responsible for (1) the rent if the assignee fails to pay and (2) damages to property (other than normal wear and tear) if the assignee refuses or cannot pay.

Replacement Tenants

When a new tenant takes over from an existing tenant – whether as sub-tenant, assignee, a replacement co-tenant, or a tenant who is breaking his lease with permission of the landlord and being released from liability – the move-out checklist/walk-thru should be completed for the old tenant, with settlement of any unpaid rent or damages to that date being taken care of before completing the change.

Question

Recently, an applicant for one of the units in my 24-unit property asked whether my property provides for Section 42 housing. What is this about?

Answer

Section 42 housing is housing that was constructed under the Low Income Housing Tax Credit program. This is a cooperative effort between HUD and the IRS that provides tax credits to the owner. The purpose of the program is to provide more low income housing. The program sometimes is required when government financing is involved – e.g., via a state bond.

The program usually provides a tax credit of 10 percent of construction cost spread evenly over the first 10 years after completion. The project is subject to the rent requirements for at least 15 years, with significant tax penalties if discontinued early. Refinancing can result in restart of the 15-year period.

The rent that can be charged for a unit under Section 42 depends, among other things, on the location of the property. Tax credit properties must include units for low-income persons. At a minimum, at least 20% of the units
must be occupied by households whose income is at or below 50% of the County Median Income (CMI) or at least 40% of the units must be occupied by households whose income is at or below 60% of CMI.

Gross rent paid by tenants may not exceed 30% of the applicable qualifying income as adjusted for household size. If utilities are paid directly by the tenant, the maximum rent must be reduced by the amount of the utility allowance (determined according to program requirements).

Section 42 units are usually only found in projects much larger than yours because the program involves a lot of paperwork both in the beginning and throughout the required term.

Question

I recently moved into a new home and plan to rent my old house.  I’m wondering who is responsible for the landscaping.

Answer

Most states allow a landlord to make landscape maintenance the tenant’s responsibility for a single-family residence (even multi-unit rentals when units have individual private yard areas). When doing so, the landscaping-related
tasks and the penalties for failing to adequately do the work should be specified in the lease in great detail.

However, there are issues of concern when doing so. Does the tenant have the necessary tools and equipment (e.g., lawnmower)? Will he do the work as often as you wish and to the level of quality you expect?

Being a landlord includes a multitude of potential liabilities and letting a tenant perform work has the potential of adding yet more. In addition to the issues raised in the above paragraph that affect the owner’s property
physically, there are other risks.

For example, if you provide the lawn mower, the tenant allows his 10-year-old kid to do the mowing, and the kid cuts off his/her fingers or toes, you will likely be sued. As another example, if the tenant injures a visitor or
passerby while performing the work even using his own equipment, you will certainly be sued. I could easily think of dozens of different scenarios.

Depending on your lease and your insurance coverage, it may not cost you money, but it will cost you time and stress. If you allow a tenant to work on your property, be sure that your insurance covers you for all possible problems
and include a clause in your lease wherein the tenant indemnifies you.

Because of the uncertain quality of a tenant’s work (if you care) and potential enforcement hassles and the potential liability it is often best to charge more rent and pay a landscape maintenance vendor to do the work, being
sure that the vendor is properly licensed and insured (including providing workers’ compensation insurance for employees), or do it yourself. This usually assures both quality and minimum risk.

All the above being said, many landlords require tenants to maintain the landscaping either because they haven’t thought about the potential problems or are willing to accept the potential problems.

IRS Audits

Most landlords filed their 2012 income tax return months ago and have since forgotten about the matter. For some landlords, especially those who push the limit regarding their rental business, the 2012 return won’t be forgotten for at least many months because as everyone knows, the IRS can pursue issues for three years after the April 15^th filing date or, if filed during an extension period, for three years after the date the return was filed. Of course, if there is any fraud involved, there is no statute of limitations.

A letter from the Internal Revenue Service creates a lot of anxiety for most taxpayers, particularly prior to opening the mail and reading the notice. Many, perhaps the majority of letters are actually quite benign – you forgot to sign your return or two digits of your social security number were interchanged. Sometimes the letter is actually good news – the IRS recalculated your data and found you’d made a math error and will be receiving a refund.

Often, there is a simply a question regarding an issue that you must respond to. Perhaps the name used for an expense of your business is unusual and an explanation is required. Sometimes, however, the letter questions income,
deductions or both or an explanation regarding some other entry is required.

The IRS defines an audit as “a review-examination” of a return “to verify the amount of tax reported is accurate.” If you are selected for one, the agency has on its website a video guide to the process.

In 2011, the IRS audited nearly 1.6 million individual returns, slightly more than 1 percent of the total filed. About three-quarters were done by correspondence, the rest through field examinations done in person by an IRS agent. Only 1 percent of people with incomes under $200,000 had their returns audited; the audit rate for those with incomes of $1 million and higher was about 12.5 percent.

The IRS says that the vast majority of taxpayers fills out their returns accurately and has nothing to worry about. However, they also remind us that they have a variety of screening processes to make sure they catch the people who are cutting corners.

There’s no magic equation for knowing which returns the IRS will select for a major audit – i.e., your chances of getting the scary letter. Some returns are selected for audit through computer screening. The IRS is looking for unreported income.  Accordingly, the IRS often focuses on taxpayers with cash earnings.

An IRS computer simply compares data from your return to average numbers for that data from people in similar types of business or at income levels. Your return could be flagged for further action if your numbers are significantly different than “normal.”

The computer may also compare your most recent return with your returns for previous years, looking for different types of entries compared to other years and/or for large variances from other years. Things that are reviewed include charitable contributions, interest income, and whether there are variations from averages in your income bracket or zip code. The computer will flag each significant variance.

The computer will also compare various types of reported income items – e.g., interest, dividends, wages, and self-employment – with W-2s and 1099s that were submitted to the government by those making payments to you. It’s important that you think through those items reported by third parties and make sure those are going to match up. This means that you have reported at least as much income within each category as will be reported by the payers. Reporting less than
that reported by payers is certain to trigger questions. Reporting more than will have been reported to the government may actually be of benefit in avoiding audits.

Assuming that you can forget about income for which you received no W-2 or 1099 is both dishonest and risky. It’s risky because there might be some reason why you didn’t receive a copy rather than the payer didn’t follow the rules in submitting the proper reports to the government – perhaps your copy was lost by the Post Office.

There’s yet another category of things that can trigger an audit of your return called “related examinations” by the IRS. Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit for some reason.

Some potential issues are of similar risk for a large percentage of taxpayers. Others are more of a problem for self-employed individuals, including landlords.

The IRS is well aware that landlords might be tempted to forget about some of the rents received in cash and/or to write off personal expenditures as rental expenses.  In order to avoid additional scrutiny rents, including cash, should be
deposited into a bank account other than other business or employment receipts and expenditures not made by check from that account should be via a credit card or other business credit lines dedicated to the rental business.

Many landlords claim deductions for a home office and this expense often attracts IRS scrutiny. However, if you qualify for the deduction, don’t be afraid to claim it. To qualify to claim expenses for business use of your home you must use part of your home:

(1) exclusively and regularly as your principal place of business (as defined by the IRS),

(2) exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business,

(3) in the case of a separate structure which is not attached to your home, used in connection with your trade or business, or

(4-6) three other uses that are not usually of concern to landlords.

All landlords utilize one or more motor vehicles in managing their income properties. However, many small business owners, including landlords, do not fully comply with the IRS requirements regarding the deductibility of vehicle use and many do not even come close. Claiming significant business auto expenses may result in a request that you furnish a copy of the mileage log that you were supposed to maintain contemporaneously with the business driving.

There’s no particular amount for charitable contributions guaranteed to catch the IRS’ attention, but inordinate amounts relative to income might do so. However, you shouldn’t shortchange yourself. As for most issues, it’s all in the
documentation. Find out what donated items sell for, at a thrift store, for example, or check valuation tools on the Internet.

The IRS will notify taxpayers of an impending audit by telephone or mail. E-mail is not used.  Just because your return has been selected for an audit doesn’t suggest you made an error or you’re dishonest. Audits can result in acceptance of the tax return without change or even result in an unexpected refund.

The IRS has a Declaration of Taxpayer Rights that sets forth what you can expect from an audit, ranging from privacy and confidentiality to professional and courteous service. Taxpayers have the right to be accompanied at an audit by anyone of their choosing or to have someone else represent them rather than even appear at the audit. Taxpayers or their representative also have the right to make an audio recording of the session.

They may appeal the judgment, either to the Appeals Office or to a court, and can request that penalties and interest be waived.

Being accurate and having the records to confirm the accuracy is the best defense in an audit. Using tax preparation software gives significant protection against mistakes in tax code interpretation if you prepare your own returns rather than have a licensed professional do so.

Again, don’t increase the odds of being audited by making careless mistakes..

Summary

The bottom line is that the most important thing in an IRS audit will be paper. Maintain good records. Keep your receipts. If you maintain good records and have receipts, you should win.

Consumer Reports and Adverse Action Notices

For tenant screening purposes, landlords may collect information from a variety of data sources including applicant supplied information, verifications, reference checking, and screening reports ordered through outside service companies. The collected information is analyzed to produce a profile of applicant behaviors in areas of interest to most landlords, namely, income/employment records, credit history, rental housing history, criminal conviction history and public records. Using a decision matrix the landlord advances or rejects the applicant on the basis of the applicant’s screening results compared to the landlord’s pre-determined minimum qualification standards.

When using consumer reports to evaluate applicants, landlords must comply with all requirements under the provisions of the Fair Credit Reporting Act (FCRA).  A consumer report contains information about an individual’s credit, character, general reputation, and lifestyle. Consumer reports include:

• credit reports from a credit bureau, such as Transunion, Experian, and Equifax or  an affiliate company,
• reports  from a tenant screening service that describe the applicant’s rental history based on reports from previous landlords or housing court records,
• reports from a tenant screening service that describe the applicant’s rental history and also include a credit report the service got from a credit bureau,
• reports from a tenant screening service that is limited to a credit report the service got from a credit bureau; and
• reports from a reference checking service that contains previous landlords or other parties listed on the rental application on behalf of the rental property owner.

The FCRA was enacted to promote accuracy, privacy, and fairness of consumer information as collected by consumer reporting agencies. Subsequent amendments included disclosure requirements for users of consumer credit reports in rental decisions, specifically adverse action notification. Next, the Fair and Accurate Credit Transactions Act (FACT Act) addressed issues of identity theft and gave additional protections to consumers regarding their credit standing. The most
recent change to FCRA requirements was the passage in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Dodd-Frank amends Section 615(a) of the FCRA to require the disclosure of the credit score when adverse action is based in whole or in part on a numerical credit score contained in a consumer credit report.

As a review from our previously published article regarding “adverse action,” Section 615(a) of the FCRA requires landlords, when they take an “adverse action” against a rental applicant based in any way on a “consumer report” from a “consumer reporting agency.” to provide an adverse action notice to that consumer. The law requires landlords to provide rental applicants with a notice that informs them of the adverse action, identifies the consumer reporting agency that provided the report that contributed to the landlord’s action, and specifies the consumer’s rights under the FCRA.

An adverse action is any action by a landlord that is unfavorable to the interests of a rental applicant. It includes not only a landlord’s denial of a rental application but also an action by the landlord that imposes a burden not required of all tenants.  Common adverse actions by landlords include:

• denying a rental application,
• requiring a co-signer or guarantor on the lease,
• requiring a higher security deposit (that would not be required for another applicant), and
• requiring an increased rent amount (that would not be  required for another applicant).

The landlord must provide the notice if the adverse action in any way is based on a consumer report that played a factor in the landlord’s action, even though the action is based primarily on an applicant’s income or prior reputation as a tenant. In fact, even if the information in the report plays only a small part in the overall decision, the applicant must be notified. This means that the landlord must usually send a notice if you hire a tenant screening company or even if just looking at a credit report. Disclosure of this information is important because some consumer reports contain errors. By being made aware of the information contained in the report, the applicant can take steps to correct errors.

The Notice of Denial Based on Credit Report or Other Information sent to the applicant advises them of rights under the Fair Credit Reporting Act and Fair and Accurate Credit Transactions (FACT) Act of 2003, (15 U.S.C. §§ 1681 and following. The notice must include:

• the name, address and telephone of the credit reporting agency that supplied the consumer report including a toll-free telephone number for credit reporting agencies that maintain files nationwide,
• a statement that the credit reporting agency that supplied the report did not make the decision to take the adverse action and cannot give the specific reasons for it, and a notice of the individual’s right to dispute the  accuracy or completeness of any information the credit reporting agency furnished, and the consumer’s right to a free report from that agency upon request within 60 days.

The Dodd-Frank amendment now (effective 2011) requires additional disclosure information if the denial was based upon the consumer credit score. The additional information includes:

• the applicant’s credit score  (the credit score found on the credit report),
• the name of the entity that created the credit report (e.g. Experian,  Transunion),
• the date of the credit report,
• the range of possible scores within the model used for the report (Experian credit score range 300-900), (Transunion credit score range 350-900),
• the key factor(s) – not exceeding four – that affected the credit score ( key factors may be found on the applicant’s credit report),  and
• a statement that a credit score is a number that takes into account information in a consumer report and a credit score can change over time to reflect changes in the consumer’s credit history.

The adverse action disclosure may be made in oral, written, or electronic form.

A credit score as reported by a credit reporting agency is not the same as a risk score as supplied by some tenant screening companies. Questions regarding screening information or scoring models should be directed to the tenant screening service company that provided the report.

Landlords who fail to provide required disclosure notices potentially face legal consequences.  The FCRA allows individuals to sue landlords for damages in federal court.  A person who successfully sues is entitled to recover court costs and reasonable legal fees.  The law also allows individuals to seek punitive damages for deliberate violations of the FCRA. In addition the Federal Trade Commission (FTC), other federal agencies and the states may sue landlords for non-compliance and get civil penalties. However, a landlord who inadvertently fails to provide a required notice in an isolated case may have legal protections if he can demonstrate “that at the time of the violation he maintained reasonable
procedures to assure compliance” with the FCRA.

The above discussion relates only to federal law. As for many property management issues, landlords must also understand and comply with more restrictive consumer credit laws that may  exist under state laws.

Best Practices for Landlords doing Tenant Screening.

It’s a risky business. Landlords must take appropriate measures to help reduce their exposure to known risks. Non-payment of rent, nuisance disturbances, property damage, or direct threats to the safety and welfare of others are examples of  high risk tenant behaviors that are costly, time consuming, and bad for business. Tenant screening is an important tool for risk assessment of the applicant before he becomes bad business.

Best practices for independent rental owners follow the best practices of multi-unit rental complexes. The most important measure to reduce risk exposure is tenant screening. Failure to screen creates potential future liabilities.

Even if you think you can afford to take some risks, taking on unnecessary risk is foolish.  Best tenant screening practices help reduce unnecessary risks.

Time is of the essence

Time is of the essence to adequately analyze and evaluate applicant information. While a vacancy can be an urgent matter, being in a hurry to install any “body” is false savings and questionable business practice. Applicants may contribute to the sense of urgency with their personal need to move quickly. Landlords should not rush to judgment, but lengthening an application process unnecessarily does not contribute to a “better” tenant. While most applicants are willing to wait for a reasonable amount of time, there is a limit to patience and common sense.  Taking a controlled approach to focus on each step of the screening and selection process provides a better opportunity to objectively analyze and
evaluate each rental applicant.

Systematic Approach

An organized, formal, written business policy provides a systematic process of screening and selecting rental applicants. It is the framework for your business operations – the way you do business – providing you and the applicant definition and description of what to expect from vacancy notice to lease-term end.

Ready to do Business

Be ready to do business when you advertise your vacancy. Your rental policies and practices should already be in place, in writing, and available to interested parties.  You should have pre-determined what types of screenings are adequate for your business and your risk tolerance and set up any third party screening service accounts as needed. Forms and agreements, reviewed for adequacy and legal compliance,  should be readily available. It is important that you yourself or your employee have scheduled time accordingly to conduct showings, screenings, and make your selection.

Landlord-Tenant Statutes

Landlord-tenant statutes cover rights and responsibilities of both landlord and tenant.  Statutes restrict what you can and cannot legally do for almost all aspects of the rental relationship. Keeping current with landlord-tenant law is a landlord duty. It is important to note that local jurisdictions may have additional regulations governing landlord duties and responsibilities such as licensing, inspections, notifications, disclosures, rent revenue reporting, and/or taxation.

Fair Housing Laws

The federal fair housing law prohibits discrimination based on the protected classes of race, color, national origin, religion, sex, disability, or familial status in most public, assisted, and private housing, with a few exceptions.

Housing that may be otherwise exempt from federal fair housing laws is still subject to prohibition against discriminatory advertising. The Fair Housing Amendment Act prohibits making or publishing statements that indicate any preferences, limitation, or discrimination directed toward a member of a protected class.

Some states and local jurisdictions may provide greater protection from fair housing discrimination for additional categories of protected classes. Fair housing compliance must be in accordance with the most stringent requirements.

Qualification Criteria

You can select the tenant you want as long as you’ve based your decision on sound business criteria, each and every applicant has been screened in the same manner under the same criteria, such criteria is applied consistently without
discrimination and in full compliance with all applicable federal, state, and local laws.

Setting high standards can in theory help minimize risk. However standards that are too high can reduce the size of the applicant pool and extend vacancy periods. Standards should be objective, measurable, and relevant
to the applicant’s performance as a tenant.

If any standard you set, despite being neutral and non-discriminatory in its intentions, has a disproportionately adverse effect on any member of a protected class you have violated fair housing laws through a practice known as
“disparate impact.”

Your rental criteria should point to the important items for your business – e.g.  the ability to meet rent, acceptable credit history, satisfactory previous landlord references, no history of evictions, no relevant criminal convictions, satisfactory employment history, and no bankruptcies, liens, or judgments. Your criteria establish the threshold level for qualification to the next level of screening.

To help reduce risk exposure, make your business decisions rationally, objectively, before the need arises. Be sure to document your qualification criteria in writing. Without a written record you may have a difficult time defending yourself against claims of misrepresentation or discrimination.

Consistency in applying your standards is a must. If you deviate from your standards, you open the door to possible liability. Fair, equitable, consistent, legal, and non-discriminatory are the watch words for your qualification standards.

However there may be a time when your standards must be adjusted to changing market conditions or business model. You can change your standards but always document the need for such changes with the date the modification became effective. Be sure the business criteria upon which the change is based is sound, legal, and defensible regarding a possible discrimination claim.

Application Process

Two forms of applicant personal identification, with at least one being a government-issued photo ID, should be required at time of application. Each adult applicant will be required to complete an application.

“The first line of defense against bad tenants is having an adequate application form.” Are you confident your application form asks the right questions, legal questions?

The application form should have a logical flow and purpose. You want to gather the information you need to analyze applicant risk related to tenancy. The collected information may also prove useful if it becomes necessary to track the tenant in order to collect a debt related to his/her tenancy.

Your rental policies and the application form itself should note that failure to provide requested information, or knowingly providing false or incomplete information will be result in the rejection or denial of the application.

Consent to Release Information

The application form itself or a separate “consent to release information” form must contain statements that authorize the landlord to verify credit, employment, and any other information, including that contained on the application, from a
credit bureau, from the creditors directly, from employers, financial institutions, and previous landlords, and from providers of eviction and criminal records. Included should be a statement that the permission includes obtaining updated reports, survives the expiration of tenancy, and can be used for any legal purpose associated with the tenancy.

Credit report

Credit reports are the most often used screening tool. There is a wealth of information contained in each section of the credit report which should correlate to applicant supplied information. Social Security number and previous address
history can be compared with application information. Debt obligations and payment history give indications of credit management. Red flag alerts are late or skipped utility payments, or liens and judgments placed against the
applicant. You may want to consider discussing items of concern with your applicant before rejecting the application out of hand.

Landlord References

Tenants move for all sorts of reasons. What you don’t want is a tenant moving because his current landlord is evicting him. Contacting a previous landlord can provide additional information to include in your risk analysis. Would this landlord again accept your applicant as a tenant?

Documents

Put it in writing!

Documentation is key to defending against charges of discrimination. Any communication with a prospect, applicant, or tenant should be documented and retained for at least the period required by statute. Not only does documentation help refute false claims; it helps to “remind” both parties as the tenancy proceeds of what was said and done. Information may be misunderstood, memories may fail, or there might be misrepresentation of what was said. Without written documentation of policies, practices, forms, interviews, or other public contact, you create potential liability. It will be your word against a claimant’s allegation. Without appropriate documentation, it never happened.

With the need for documents, comes the need for document control. You must have a plan for security of documentation – how it is stored and accessed; retention of documents; and disposal requirements of documents no longer needed.

Summary

In setting practices for your business, consider what works for you with the caveat of compliance with applicable laws, the local market conditions, and your risk tolerance. The best practices will be those practices that deliver adequate
information to help protect yourself and your investment.

Can a Landlord reject potential tenants if the rental properties septic system can only handle 3 people and they have more?

Question

I am renting a duplex that has two bedrooms and an office. It is on a septic system and cannot handle more than three persons living in the house. I am in the process of advertising and screening tenants and want to know if it is allowable to reject a tenant based on the number of persons, including children, that exceeds three people?

Answer

Occupancy issues can be risky because there can be different definitions and standards at federal, state, or local levels.  Various standards in use include number of bedrooms and unit area. However, the floor plan and other issues must be taken into account. For example, absent some physical limitation, a 2-bedroom and office unit may be considered adequate for a half-dozen occupants, possibly even more depending on other issues regarding the floor plan.

However, one of the safest reasons for having a maximum occupancy limit is when some physical issue limits the number of occupants even though the size, number of rooms, and floor plan do not. The capacity of water and septic systems will generally be in this category.

In order to avoid any claims regarding fair housing law violations, it is important to avoid any indication that protected classes are being discriminated against. Protected classes sometimes vary among federal, state, and local jurisdictions, with number of classes and degrees of protection increasing as level of government decreases.

I would strongly recommend that you have some written documentation from an independent qualified expert providing his professional opinion that a maximum of 3 occupants should be allowed. Preferably, this would be one that is licensed by your state regarding septic systems.  Otherwise, considering the number of rooms in the unit you may well have trouble defending against a claim that you are in violation of federal fair housing laws, especially the protected class of “familial status,” although I can imagine other federal protected classes that could potentially be used against you. A fair housing law investigator is unlikely to believe that a septic system of such limited capacity was installed for a duplex unit having
at least one unit with two bedrooms and an office room. The costs of defending yourself and the potential financial and other penalties if unsuccessful would have easily paid for installation of several additional septic systems or one
very large one.

You don’t include details about the entire duplex building, so it might be that the septic originally served a smaller building that has since been modified into a duplex. In this case there might be zoning and/or code violations that could cause additional costly problems if the matter gets out of hand.

Notwithstanding the fair housing issue there is another issue you might want to consider – rating the capacity of the subject septic system below actual capacity. In doing so you would almost certainly limit the size of your potential pool of qualified applicants. Even limiting occupants to 3 rather than 4 has a significant potential impact on number of applicants. Three occupants allow 3 adults or 2 adults & 1 child or 1 adult & 2 children. This disallows 2 parents and 2 children, a common family size, possibly a larger class of applicants than any of the permitted ones, as well as 1 adult & 3 children. Even if each class of occupant groups is of the same size, you will potentially be reducing your pool of qualified applicants by 40 percent if you can’t allow 4 occupants. Fewer qualified applicants usually results in longer vacancies or lowering of qualifying standards.

California Depreciation Information for Landlords and Tenants

Question

This is a clarification of a previously asked question regarding CA depreciation. I am concerned about depreciation as used when deducting damages from a security deposit or when suing for damages.
Answer

The depreciation that is allowed when charging for damaged carpet is not defined by law in most states. However, if the matter goes to court before a knowledgeable judge and with the tenant being knowledgeable or having a competent attorney then the method used must be reasonable. This usually means that when calculating damage the landlord must take into consideration:

• expected life of the carpet when new,
• condition of the carpet when the tenant moved in (if not new),
• length of tenancy,
• condition of the carpet when the tenant moves out, and
• That the tenant cannot be charged for normal wear & tear.

Proration replacement cost – You cannot charge the tenant for the total cost of replacing the entire carpet in the unit. There are two different issues regarding this issue. First, depending on the floor plan and the location of carpeting, it may be acceptable to replace carpeting in only certain rooms. Second, wherever carpeting is replaced you cannot charge for the full cost of carpeting, but must allow for depreciation.  The percentage of cost of replacing damaged carpet (labor and materials) that may be charged against the tenant is determined by dividing the number of years the carpet has been in service (including the period the unit was occupied by the tenant who damaged the carpet) by the useful life of the carpet. There is more than one number that might be justifiable for useful life, but it is usually least arguable to use the number of years warranted by the manufacturer.

As examples, assume a carpet that the manufacturer had warranted for 15 years. If the carpet was 10 years old when the tenant vacated the unit, the tenant can be charged 5/15 = 33.3% of the cost of replacement carpet, whether the entire unit is re-carpeted or only some of the area. If the carpet had been new when the tenant moved in a year earlier, the tenant can be charged 14/15 = 93.3% of replacement cost. If the carpet was 14 years old when the tenant moved into the unit and the tenant remained for one year or more, the tenant cannot be charged for any part of the cost of replacement.

Similar considerations must be given to window coverings, appliances, and other components of a rental that would be considered capital items (have a typical useful life of longer than a year) when they require replacement rather than repair. The tenant can be charged the actual repair cost for anything being repaired due to the actions or inactions of the tenant or his/her guests.