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

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Q1

One of my tenants smokes marijuana on a somewhat regular basis.  When I approached him about it he stated that he does this in practice of his religion and that he will sue me for violation of his rights if I take any actions related to the matter.  Can he really do this and do I face any risk if I begin his eviction?

A1

You should counsel him that it is not an issue of religion but a matter of him breaking the law and, assuming you have a good lease agreement, a matter of defaulting on the lease.   Accordingly, if he continues his unlawful conduct, you must proceed with eviction.   This, of course, assumes that you apply the same rule against other tenants regarding use of illegal drugs on the premises.

Fair housing laws prohibit discrimination of the basis of religion, but your action relates to criminal violations, not on account to religion.

Of course, if marijuana use for medical reasons is legal in your state, you must be sure that the manner in which he is using it is in violation of law of your state.   If he is not in compliance with any medical use law that might exist in your state or if he is dealing drugs, you should be able to proceed with eviction in spite of any medical use law.

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Q2

I have 3 tenants (in their mid to late twenties) living in a townhouse.   I am getting reports from neighbors of their constant weekend parties, loudness, and now I just learned they crashed into a fence at the back of the property.   They are six months into a 1 year lease.   What course of action is open to me?

A2                                                                

Regarding the noise, you can serve them with a written notice, in the manner required by the law of your state, to cease disturbing the neighbors.   You should cite the relevant clauses in your lease agreement, rules of the HOA, and any specific local noise ordinance.   If they continue disturbing neighbors, you could start an eviction, again, in accordance with the requirements and procedures of your state’s law.

If you can prove that they did the damage to your fence, get a firm estimate to repair the fence and demand payment. If they fail to pay, file a lawsuit in small claims court for the damages.   You may be able to instead evict them if they fail to pay for the damage, but that option will likely depend on the clauses in your lease agreement and/or the law of your state.   In either case, getting a judgment regarding the damage provides leverage in collection of the cost and will help in getting an eviction judgment if necessary to proceed with eviction.

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Q3

The names on a credit report are sometimes significantly different than the names on the application.   Nicknames usually are not far from the name applicant wrote down in the application.   Can this be due to the applicant using a SS number that’s not actually his?

A3

Before even obtaining credit reports on an applicant, landlords should first verify identity and make copies of verifying documentation.   ID verification should be considered the most important screening procedure.   It can be worse to pull a good report on a false ID than to use no screening at all.   Photo IDs are obviously the most useful and can include driver license, passport, military ID, photo credit card, student ID, etc.   Differences between different IDs should be questioned.

It is not always possible to independently figure out exactly what’s going on.   It could be something as innocent as an accidental mistake by the applicant when supplying the information or a clerical error by the credit reporting agency. The first thing you should do is discuss the matter with the applicants and see if they have a logical and believable explanation.

However, whether or not there is a valid reason, you should not be depending on only a credit report for tenant screening.   Landlords should always verify ID as discussed above and also reconcile the different items of documentation and screening reports.   This means comparing information on application forms, credit reports, criminal checks, eviction reports, previous landlord inquiries, and employment verifications.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Surviving a Tax Audit

Since the beginning of the new millennium, tax audits have increased to higher levels than was seen during the last decade of the previous century. In light of the recent and still lingering serious economic downturn, further increases in enforcement will almost certainly occur under the Obama administration.

Whether the number of audits is increasing or decreasing or will do so in the future is somewhat unimportant because the probability of the average business owner being audited is actually quite low. However, no matter what it is, the probability is not anywhere near as low as the probability of winning the lottery. Accordingly, we will all want to minimize the probability of a tax audit and maximize our survival condition if there is an audit.

In the unlikely event that you do receive an audit notice from the IRS you should not automatically panic. Most IRS notices are simply requests for some specific item of clarification and/or verification. Sometimes notices simply tell you that you miscalculated taxes owed by a relatively small amount and that (1) you need to send an additional amount or (2) you will be getting a refund or credit.

Even when there is an audit, it isn’t always a tense, face-to-face encounter with an agent. A letter from the IRS saying you added wrong also counts as an audit, at least in the eyes of the Treasury Department. There are basically three types of audits:

•  Correspondence Audit – The IRS requests a mailed reply to relatively uncomplicated issues. For example, the IRS may request proof of one or more deductions. Under many circumstances, taxpayers have a right to do the audit by mail rather than meet an auditor face-to-face.
• Office Audit – The IRS requests that the taxpayer bring documents regarding specific issues to an IRS office. For example, the IRS might want to see all the taxpayer’s bank account statements.
• Field Audit – The IRS agent comes to the taxpayer’s home or office.

In the event you do face an audit, you should consider hiring professional help. Obviously, if an accountant prepared your tax return, he/she should be your first choice if experienced in dealing with the IRS. If you don’t have an accountant, pick a CPA or tax attorney who is experienced in dealing with the IRS. If possible, find one who has previously dealt with the local auditors.

There are a number of advantages in being represented by a professional. One issue is that the IRS backs down in at least one-third of disputes and this is much more likely the outcome when a taxpayer is represented by a professional who has at least the same knowledge of tax law as the auditor.

It can even be further advantageous for the professional to meet the auditor without your presence if qualified to do so. A qualified professional will know what must be provided and what shouldn’t be provided the auditor. The professional won’t know and is not expected to know the answers to many questions and so can’t volunteer “incriminating” information. The professional can promise to provide answers after asking you.

If you will be attending the audit, remember the following DOs and DON’Ts:

• Do pick a time and place for the audit that is convenient to you and allows for adequate preparation – this is your right.
• Do consider recording the audit to prevent the IRS from changing the rules part way through – this is your right, but doing so gives the IRS the same right.
• Do limit the scope of the audit to those issues of the notice – this is your right
• Do answer as briefly and concisely as possible.
• Do remember that auditors can be wrong about tax law.
• Do ask to speak with the auditor’s supervisor if you feel that the auditor is being unfair or does not understand the issues.
• Don’t lie.
• Don’t guess if you don’t remember.
• Don’t volunteer information not requested.
• Don’t provide documentation that was not requested or related to the issue.
• Don’t hesitate to pause or postpone the audit if you feel that things aren’t going well so that you can consult with your professional before continuing.
• Don’t sign any forms at the audit that might take away your rights to claim deductions, appeal, or prevent enforced collection.

Expanding on some of the above points, if you choose to appear for an audit on your own, restraint is your best ally. Provide only the information the IRS specifically asks for and do so without going overboard. The more you talk the more risk of saying something that the auditor hadn’t even thought of and increasing the scope of the audit.

Just because the auditor asks about something doesn’t mean you’ve done anything wrong. If you don’t know the answer to a specific question, don’t guess. For example, if asked the source of funds for a particular bank deposit and you’re not sure of the source, simply answer that you don’t remember, but will research the matter and provide the answer as soon as possible.

Don’t consider an auditor to be infallible. In fact, some observers claim that auditors are wrong in more than half of cases. If you think that an auditor is wrong about an issue, ask to speak with a supervisor or get professional help.

The IRS has the legal right to look at your financial records, but, whether you will appear at the audit by yourself or with a tax professional, it’s advantageous to do the following:

• Talk with the IRS auditor ahead of time in order to understand the issue(s) and to determine exactly what documentation you need to bring with you.
• Take with you only the documentation being requested and organize it so that it’s easy for the auditor to find what’s needed. You don’t want the auditor looking through a lot of unrelated documentation and finding other things to question. For any missing receipts, use other documentation to provide the required information. For example, if an expense invoice is missing, use a canceled check or credit card statement to show the expenditure.

Finally, if you are being audited before filing a return for the most recent tax year, you can avoid that year’s return being included in the audit by filing for an extension.

Additional Information
For additional discussions regarding tax issue in considerably more detail than is provided by this series see our “9 Steps to Avoiding & Surviving a Tax Audit” Mini Training Guide and tax related lessons of our “Buying Income Property” and “Managing Income Property eCourses.

In Review

In Part 1 of this series we discussed the reasons why every business, including the real estate rental business, should have a disaster plan and the preliminary steps to take toward developing a plan and in Part 2 we briefly discussed the development of a plan. In this final part of the series we briefly discuss some additional issues related to developing and implementing a plan.

Take Care of People

Planning and protection of the people in your business are critical components of your disaster plan. Employees, customers (tenants), clients, and your family deserve your best attention. A disaster plan demonstrates your concern for their welfare and safety and your efforts to protect their interests.

Employees

Because employees are the most vital asset for any business, a good disaster-recovery program must begin with preparing your employees in case of emergency and protecting them with a disaster plan.

The very basic step to protect your employees is to make sure that they have the telephone numbers to call in an emergency. The telephone numbers for police, fire department, utility companies, hospitals, and poison control centers should be posted in work locations.

Plan what you could do to ensure your employees’ safety. Develop an evacuation plan and train all employees in what to do in case of fire or other emergency.

Family

Families will always have concerns for the safety of their loved ones. Whether a business owner or an employee, letting families know of your safety and whereabouts is an important procedural part of your disaster plan.

Customers and Vendors

When a business experiences a disruption or closure, customers (tenants), clients, and vendors are naturally concerned how that might impact their business. Property management company clients will want to know about their properties. Vendors will need to know whether to show up as previously scheduled.

Tenants

Landlords and property managers have people to think about that most other types of businesses don’t have – tenants. Without tenants there will be no income for either the owner or the management company even though many of the expenses will continue.

Thinking about the tenants will be of benefit in several ways. First, tenants will feel that the landlord is concerned about their safety, health, and/or security, potentially improving landlord-tenant relations. Second, it will probably provide some protection from liability in case of actual occurrence of an event for which education was provided. Third, it may reduce risk of damage to your property.

Just as discussed above, basic emergency telephone numbers should be made available to new tenants and during a move-in orientation session or the move-in inspection, the landlord or property manager should provide instructions for water and gas shut off valves, circuit breakers, fire extinguishers, smoke alarms, or other equipment.

Priority should be given to fire prevention and fire safety practices because fire is the number one hazard that affects income property. Be sure your rental properties meet all safety requirements in accordance with building codes and fire regulations.

Investors who employ property management services and are themselves not involved with operation or management of the property should determine that the management company considers disaster preparedness for both the company and the tenants.

Take Care of Business

Once you’ve figured out how to keep your people safe, you’ll need to make sure that the business itself survives as well, whether the business is the management of your own rental properties or a property management company that manages properties for investors. That means implementing a plan that addresses your key business functions, who’s responsible for them, and what equipment or services you’ll need to keep running.

Recovery from interruptions in business can vary from a matter of a few hours to a few weeks or months depending upon the nature and severity of the interruption. If the disaster covers a widespread area, resource availability for materials and personnel may be limited and would further complicate recovery efforts.

Self Reliance

When it comes to almost any disaster, you shouldn’t count on Uncle Sam – or anyone else – to step in and fix problems. While city, county, and state officials may be sympathetic to your woes, they often can’t help. By the time you’ve filled out the applications and finally get some money, you might be out of business or your tenants may have all left.

Accordingly, the business that can be self reliant in the event of a disaster has an advantage. The quicker a business responds to crisis, the quicker it’s over and the less damage will result.

Communications

After a disaster strikes, the crisis team’s first job is communication – especially spreading the word to employees about the event and how the company plans to deal with it. For a crisis, the first 24 to 48 hours are critical. Misinformation fills a vacuum and without adequate communication, a lot of misinformation can get out and really damage a business.

For a sole proprietor landlord of only a few units, communication with tenants is often the highest priority.

Be sure that you have a way of contacting your family, employees, tenants, vendors and professionals (e.g., insurance agent or attorney) if you need to do so. Keep contact lists of telephone numbers, cell numbers, and email addresses of those contacts with you for ready access no matter where you are when disaster strikes.

Train & Practice       

Once you get the basic emergency action plan written, tell your employees or, if no employees, the family members or other persons you expect to take over in your absence. Make sure they know what’s expected of them in an emergency.

Training is an important and relatively inexpensive part of emergency preparation that may save a life. More important, proper training can prevent an emergency from becoming a disaster and make all the difference between closing down operations for a few hours and being out of business indefinitely.

Following adequate initial training, most businesses should run practice drills on a regular basis.

Tenant Issues

One of the issues that must be considered in a real estate investor’s disaster planning is what happens to the tenants in event of complete or partial loss of their leased premises and what, if any responsibility the owner has in such an event.

The landlord tenant laws and case laws vary from state to state but most states hold that if a rental property fails to meet the basic habitability tests, the tenant is under no obligation to remain. In addition, local laws may also have specific health and safety requirements for rental properties.

In the event of a natural disaster causing destruction of the leased premises, the implied warrant of habitability holds the landlord responsible for repairing and maintaining the livability of the leased premises. Because the rental home was significantly damaged by a natural disaster or an event beyond the control and responsibility of the tenant, the tenant has the right to consider the lease at an end and move out of the leased premises. The tenant’s security deposit which is held to cover unpaid rent and any damage to the rental unit during the term must be returned to the tenant.

Thus the landlord/investor will have no rent coming for uninhabitable units and only a possibility of partial rent for partially uninhabitable units. Under certain circumstances the landlord may be responsible for assisting the tenant until replacement housing can be found.

A tenant’s problems are greatly reduced when the tenant has insurance that covers damage or loss of personal property from a named peril. Tenants may elect to add additional coverage for loss-of-use or additional-living expense which provides some money to cover things such as rent for temporary quarters following a disaster. Special coverage may also be available to tenants for disasters such as floods and earthquakes.

Fewer problems for the tenant will usually mean less trouble for the landlord from that trouble. Accordingly, tenants should be informed when signing the lease agreement that the landlord’s policy does not provide benefits to tenants and tenants should be encouraged to obtain a comprehensive rental insurance policy.

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

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Q1                                                

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

A1

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

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

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

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

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

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

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Q2

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

A2

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

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

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

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

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

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

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

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

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Q3

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

A3

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

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

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

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

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

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

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

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

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

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Q1

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

A1

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

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

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

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

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

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Q2

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

A2

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

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

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

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

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

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Q3

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

A3

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

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

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

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

When Co-Tenants Split

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

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

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

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

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

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

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

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

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

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

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

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

Replacing or Adding Co-Tenants

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

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

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

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

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

Security Deposit

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

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

Rent Payment

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

Unauthorized Occupants

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

Co-Tenant Agreements

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

Lease Defaults

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

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

Domestic Violence

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

In Review

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

Develop a Plan

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Insurance

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

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

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

Q1                                                

Is it legal to rent my own condo without a broker?

A1

To my knowledge (and I’d bet a lot of money on it), no governmental jurisdiction restricts the right of an owner to manage his own properties. Most, perhaps all states require a license to manage property of another for compensation, some requiring a real estate broker license, others having a special management license.

Be sure that you know and follow your association’s CC&Rs, Bylaws, and Rules & Regulations related to rentals and that you provide copies of those documents to tenants. Also be sure that your lease agreement explicitly covers those items by including a clause whereby the tenant acknowledges having read the documents and promises to abide by them. I highly doubt that an association can legally require an owner to use a broker.

Those who do manage their own properties should be sure that they understand and follow all federal, state, and local laws related to rental property – including those related to fair housing, tenant screening, and lead-based paint. Even if using a broker, one must be sure the broker is knowledgeable and follows the laws because the owner will ultimately be at risk for a broker’s mistakes.

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Q2

An ex-tenant moved to another state after I got a judgment for damages. What can I do?

A2

A judgment obtained in one state is usually collectable in another state. In fact, the only defense a debtor would usually have against collection is if he could convince the court at his new location that the state where the judgment was obtained was not the proper jurisdiction. This is unlikely to be possible when the litigation related to rental housing. Check with the clerk of the Court where the debtor is now located to determine the exact procedure for that particular Court.

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Q3

I recently evicted tenants who had 4 months remaining on a 2-year lease when they moved out. I am keeping the security deposit due to unpaid late fees and damage of a counter top and two large stains on bathroom floor. I just received a phone call from their supposed lawyer, threatening a law suit against me for the deposit. I have pictures of damage receipts for replacement costs, which exceeded the amount of damages, and detailed list of each month late fee was not paid, along with copied checks and deposit slips. I sent this information to them explaining why they were not receiving the deposit back. Do I have all of my angles covered? Can I take them to court for the remainder months of the lease and yet unpaid damages?

Am I legally in the wrong for not having a joint inspection and only sending an accounting for the non-returned deposit.

I live in Ohio and believe the time for providing an account summary of the deposit is 30 days. I thought I read it was 30 days after the tenants had actually moved out. They moved out on the September 4th I sent the certified letter to them on September 27^th.

Am I legally in the wrong for not having a joint inspection and only sending an accounting for non-returned deposit?

A3

The answers will depend somewhat on whether or not you provided an accounting for the non-returned security deposit within the time required by the law of your state. As you thought, it appears to be 30 days in Ohio. If you can prove they moved out on September 4^th and you have a Certified Mail receipt, you should be OK regarding timeliness.

My cursory research did not turn up anything to show that Ohio requires a joint move-out inspection, but that is something you could further research.

In some states the requirements are different, even eliminated when a landlord actually fully completes an eviction, not simply terminates their tenancy.

If they were actually fully evicted, the date would be the date the sheriff removed them. If there was not such a removal, you would hopefully have some evidence to indicate the date they left.
Anyone can sue anyone else for any reason, real or imaginary. The important thing is to appear in court to defend yourself. Otherwise, the plaintiff will likely obtain a default judgment of whatever was asked for in the complaint.

If you are worried, consider having a competent landlord-tenant law attorney advise you and perhaps send a letter on his stationery wherein he takes the position that you followed the law. If a suit is actually filed against you, keep in mind that it is almost always best to be represented in court by an attorney if the other party is represented by an attorney.

Another possible approach is to file your own lawsuit for yet unpaid damages or other items, as filling first could help support your position.

Finally, you should consider negotiating a settlement that is acceptable to both parties after finding out which particular charges are objectionable to the ex-tenant. Going to court costs time and money.

Q1

I have some concerns regarding screening for criminal records. What should the rejection threshold crime be?

A1

You are right to be concerned about this issue. A comprehensive discussion of this subject is way beyond the scope of this forum, but I’ll briefly mention a few issues.

In general, convicted criminals are not a protected class under federal fair housing laws. An exception is that those who were convicted of past drug use, as past drug use is considered a disability. Those currently using drugs or those convicted for the manufacture or sale of drugs are not protected. However, state or local laws may have protected classes not in federal law or may more generally prohibit arbitrary discrimination on the basis of personal characteristics. Regarding the latter, it is possible that a specific judge might rule that a criminal record is a personal characteristic in a jurisdiction having such a law.

There are a number of issues that must be considered when using criminal record in screening. First, (and probably most important) you must be sure that the applicant is really the person in the criminal record report. Second, your qualifying criteria related to criminal records, which should be in written form, must be reasonable and related to the safety of others. As examples, you could be treading on dangerous ground by denying housing to a person convicted of embezzlement or even someone convicted of armed robbery as a teenager 25 years earlier with no subsequent criminal record. Third, your criteria must be applied equally to all applicants in order to avoid fair housing claims. You cannot do criminal checks on some applicants and not on others or have different criteria because of the applicant’s appearance or other characteristic. Fourth, you must understand that the criminal record check does not guarantee an applicant is not a criminal, as there are numerous reasons why the report might not show a  single conviction for even repeat offenders.

Accordingly, be sure that you understand federal, state, and local anti-discrimination laws if you are using criminal record reports when screening tenants. You should consider consulting a competent local attorney who is knowledgeable about the specific issue for advice regarding your decision criteria.

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Q2

Is it normal that both my wife and I be required to sign a personal guaranty when refinancing a property owned by an LLC of which I am the sole member?

A2

If an LLC, corporation, or other limited liability entity is not highly financially qualified (e.g., a GMC or Microsoft) at least some of the owners or managers should expect to personally guarantee the loan unless it is to be non-recourse. It is often required that both spouses sign as guarantors for loans because, in many states, the other spouse’s income and assets cannot otherwise be made liable for the loan. Similarly, landlords must consider the same issues when leasing to a limited liability entity.

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Q3

Can I require a tenant to be responsible for all repairs and maintenance?

A3

That might depend on a number of things, including the state where the rental property is located, the type of rental unit, and the types of repairs you want to include.

In some states, the tenant cannot be made responsible for some types of repairs. The theory is usually that a current tenant should not be responsible for repairing things that were nearly worn out when he moved in, particularly things that are costly. The type of rental unit might also make a difference. In general, a tenant can likely be made responsible for more repairs in a single-family home than for a unit in a multi-unit building.

The type of repair for which a tenant can be made responsible might also depend on whether it’s a $25 dollar repair or a $2,500 repair. You should not expect to  make a tenant pay for replacement of a non-repairable HVAC system that is 20 years old. When considering tenant repair responsibilities, you must always take into account landlord responsibilities under federal, state, and local habitability laws.

However, just as important as “can you do it” is “do you really want to do it.” Even if you can legally require the tenant to be responsible, you should understand that it might not be beneficial for you to do that. I’ll mention a few of numerous possible issues.

First, the tenant may neither make the necessary repair nor report the problem to you. This might occur because (1) he doesn’t know how, (2) he hasn’t sufficient funds available, or (3) he just simply doesn’t want to spend the time and/or money to deal with the problem. Deferral of repairs and maintenance can result in substantial collateral damage. For example, failure to repair a leaking roof can lead to ceiling and/or wall drywall destruction and serious flooring and/or cabinet damage. A neglected $100 repair by a licensed roofing contractor can turn into thousands of dollars in repairs, the costs for which you may never be able to collect from the tenant.

Second, the tenant may (1) fail to hire the necessary professional services for complex jobs or for tasks that by law require use of licensed contractors, due either to lack of knowledge of the law or unwillingness to pay the cost of a qualified contractor, or (2) do inferior work himself, potentially even increasing the damage in the long-term because of collateral damage. Bad work is often more costly to correct than having it done correctly in the first place. For example, he may perform plumbing repairs that later fail, causing costly damages to your unit and/or to property of a subsequent tenant. Even worse, he may illegally do work (e.g., electrical or gas) for which state law requires a licensed contractor and/or local law requires a building permit. Your liability could be greatly increased if the faulty work resulted in serious injury or death to a subsequent tenant or other party.

Third, in the course of doing the work the tenant may cause injuries to third parties or may himself be injured. You may be held liable and, for some possible scenarios, you may not be covered by your insurance.

Finally, there are circumstances under which there could be issues regarding payroll taxes and/or worker’s compensation insurance because you assumed the tenant could be treated as an independent contractor whereas the IRS and/or state taxing authorities would classify the tenant as an employee.

The bottom line is that it is usually much better to charge a higher rent and retain responsibility for most, even all repairs. If you do decide to make tenants responsible, you need to (1) be sure that your insurance covers you for any liabilities resulting from repair work being done by a tenant, (2) have adequate lease clauses regarding the issue (including clear definitions of what items are the responsibility of tenant and landlord, respectively), and (3) make regular inspections of the property to be sure that necessary work in being done in an acceptable manner.

Disaster Planning – Part 1

Introduction

This article is the first in a 3-part series on the subject of Disaster Planning.

Is your real estate investment business or property management business ready for a fire, a hurricane, a flood, or whatever other unexpected event might occur tomorrow, next week, next month, next year, and/or beyond? It is not only 9/11 or Katrina level disasters that should be of concern. Are you even prepared for a hard-drive failure that could occur at any time?

According to the U.S. Department of Labor, over 40% of all businesses that experience a disaster never re-open and 25% of the remaining businesses close within two years. The smaller the business the less likely that it will be prepared.

Many small business owners believe that preparing for disaster requires more money and/or time than is available. However, the most important steps for surviving a crisis cost relatively little. Being totally unprepared can be the costliest plan of all.

The only certainty about the unexpected is that it will happen some day. Even a minor incident can become a disaster if not managed properly. Disaster planning is like insurance in that you have to put things in place prior to occurrence of the disaster, not after the fact.

What Could Go Wrong?

There are an infinite variety of things that could go wrong for a landlord or property management company in the course of running the business.

How about a burglary of your office? Would they get your computer and your backup CDs lying on the desk or the external hard-drive under the computer desk? What if they stole the files containing personal data regarding all applicants for vacancies over the past 5 years? Do you know the legal penalties and potential financial liabilities for not adequately protecting this information?

Most business owners are fully aware that things can go wrong, but this awareness does not always translate into action. The human component of disaster planning is the weak link due to reluctance, fear, or uncertainty on how to plan.

The impact of an event may be quite different for different businesses. What might be considered a disaster for some is just an annoying disruption for another. For effective disaster planning, all those involved in a business need to have the same definition of a “disaster” and an understanding of what to do, how to do it, and who should do it.

The first thing you must do is complete what’s commonly called a risk assessment. The purpose of the assessment is to (1) identify what could go wrong, (2) analyze the effect on your business if something does go wrong, and (3) determine what priority you should place on each event so that you can minimize your risk exposure by committing limited resources to the greatest risks.

During this assessment, you must think of all the risks and threats that your business faces. Threats include anything that could happen to your employees, tenants, family, property, equipment, and records.

The degree of risk for different types of disasters varies significantly in different areas of the country. Every area in the country is subject to some type of natural disaster, whether floods, hurricanes, earthquakes, ice storms, high winds, wildfires, or landslides.

California has a greater risk of earthquakes than Florida, while Florida has a greater risk of hurricanes. However, even though a particular event is unlikely or has never happened before does not mean that it will not happen tomorrow. For example, the biggest earthquake in recorded history that occurred in the continental U.S. was in Missouri in 1812, not in California.

For most other categories of threats, the risks are somewhat similar throughout the country, although infrastructure-related threats can vary greatly between one city and another. Of course, the categories of risks and threats depend upon the type of business. The point is that risk assessment must be customized to each specific business.

Vulnerability

After identifying potential risks and threats, you must decide how vulnerable you are to each of them. You must rank the threats in two different ways. First, rank them in order of frequency. For example, how often does power to your computer get interrupted? List the expected number of months between events. Obviously, this is difficult to do for those events that might occur years apart.

Impact

You must next rank your vulnerabilities to these threats by the financial impact they’ll have on your business. That is, how much would it cost to replace or repair?

For hardware (e.g., a new computer hard-drive), this is not simply the cost of purchasing the hardware or of obtaining a replacement if under warranty. The cost must include (1) the cost of the down-time until you can obtain a replacement or repair and get it installed, (2) the labor costs involved for installation of the drive, (3) the cost to reinstall all the software, and (4) the cost to recover data from your backup or to recreate or update the lost data if a backup doesn’t exist or is not recent, respectively.

Finally, it must take into account lost business during the down-time. For a landlord or a property management company, this might include the inability to collect rents.

Risk Exposure

Now divide the cost of the event by the months between occurrences of that event to give you a measure of risk exposure for each threat. The higher number, the more important it is to protect yourself from that threat or at least minimize the damages resulting from it.

Of course, in the real world, the numbers are not easy to come up with, will not be very accurate, and the answers will not be exact. However, the method does provide a way to prioritize disaster planning tasks. Accordingly, it is much better to do the analysis using guesses than to do nothing.