You learn something new every day!

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Question gives insight into IRS collection procedures against JTROS properties

In August of last year, an excellent South Carolina real estate lawyer raised this issue with Underwriting Counsel in our office:

The property owners are Sally Seller and Samuel Seller, as joint tenants with right of survivorship. Sally Seller died January 7, 2017. A federal tax lien was filed against Sally Single, Mrs. Seller’s maiden name, March 3, 2014. Mr. and Mrs. Seller were married in April 20, 2015. Please confirm that we should either pay off this lien at closing or obtain a release from the IRS.

Title insurance underwriting is all about pre-closing risk prevention and risk management, and I always joke that underwriting is more of an art than a science. This is true, in part, because few issues in the law are black and white. Most lawyers will confirm that a fair amount of gray area exists in most legal questions. But I digress.

The truth is that when a trusted, intelligent real estate lawyer calls her friendly South Carolina title insurance underwriter and says, in effect, “I should deal with this title problem at closing, shouldn’t I?”… that is an easy answer! Unless the Underwriter knows of a magic solution to eliminate the title issue, the friendly title insurance Underwriter will almost always respond, “Yes, please take care of that issue at closing.”  That’s exactly what our Underwriter did in this case last August.

Around Halloween, a follow-up question was raised:

The sellers’ attorney has been working on obtaining a satisfaction for the IRS lien, but the IRS has told him that the lien will not be released or satisfied because the taxpayer is deceased. IRS Agent Arnold Adams (IRS ID#10000797284)* referred me to Notice 2003-60. The IRS agent further said it will not file a release of lien for the convenience of title insurance companies and mortgage lenders**, but that the tax lien upon the death of a joint tenant is extinguished and not collectable on the basis of U.S. vs. Craft*** and its application.

The IRS notice linked above is entitled “Collection Issues Related to Entireties Property”. Every South Carolina dirt lawyer knows that we do not have a tenancy by the entirety form of ownership in South Carolina. If we don’t have that form of ownership, then does this IRS Notice have any application in South Carolina?

Married couples in South Carolina can own properties as tenants in common, joint tenants with right of survivorship or joint tenants with an indestructible right of survivorship under Smith v. Cutler.****

Several years ago, my friend and fellow South Carolina dirt lawyer, Paul Dillingham, called me to twist my arm to write an article with him for the Bar’s South Carolina Lawyer magazine, linked here, about a couple of deed drafting traps that were troubling him. In that article, we questioned whether Smith v. Cutler had created, in effect, a tenancy by the entirety form of ownership. That case dealt with property owned by couple pursuant to a deed with this language:

“for and during their joint lives and upon the death of either of them, then to the survivor of them, his or her heirs and assigns forever in fee simple”

The case held that property owned pursuant to the quoted language cannot be partitioned. If the property cannot be partitioned by the creditor of one owner, then the IRS Notice would have application in South Carolina. Apparently the IRS agent who was questioned for this closing believes the notice does apply in the Palmetto State, but please note that the question before the IRS agent didn’t deal with the Smith v. Cutler form of ownership. It dealt with a standard joint tenancy with the right of survivorship.

Did the IRS Agent give our South Carolina good advice? Would all IRS agents give the same advice? Can we ignore this IRS lien for the purposes of closing? What do you think?

This is fictitious name and number. Don’t try to contact this IRS agent!

** That wasn’t very friendly!

*** 545 U.S. 274 (2002)

**** 366 S.C. 546, 623 S.E.2d 644 (2005)

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Federal class action seeks to invalidate non-condo HOA foreclosures

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Is there authority for these foreclosures under SC law…or not?

On January 9, a lawsuit was filed in the Federal Court in Charleston seeking to certify a class of plaintiffs who have faced foreclosure in situations where the Horizontal Property Regime Act was not involved. In other words, the properties are not condominiums and are not subject to the statutory scheme that establishes lien and foreclosure rights in owners’ associations. The power to foreclose these properties is supported only by restrictive covenants, that is, only by contract.

subdivision

The complaint refers to a good faith estimate that one-third of all South Carolinians own property subject to restrictive covenants establishing owners’ associations, and those associations manage more than $100 billion in assets. Many of the properties are separate lots of land in contrast to “slices of air” in condominium projects.

The defendants in this class action suit include five homeowners’ associations in various counties in South Carolina, four law firms who represent the associations in their foreclosure actions, and five management companies who manage the business of the associations in various counties in South Carolina. All are said to be representative of the associations, law firms and management companies who do business across the state.

The class intends to exclude all associations governed by the Horizontal Property Regime Act. It also excludes employees, owners, officers, partners and management of the law firm and management defendants. The law firm and management defendants are alleged to be agents of the owners’ associations.

The main issue in the suit is whether non-condominium associations have the right to file liens and prosecute foreclosures for unpaid property assessments under South Carolina law. Underlying issues include whether the defendants have violated the Fair Debt Collection Practices Act, whether they have interfered with the plaintiffs’ contracts with their mortgage holders, and whether they have the power to lawfully evict homeowners for unpaid assessments.

The owners’ associations are typically established as non-profit corporations, and the suit questions whether non-profit corporations have the power to create liens for unpaid dues or assessments prior to obtaining judicial judgments.

The suit accuses the defendants of seeking to use the equitable remedy of foreclosure in actions that seek monetary damages for contractual breaches. The inability to use equitable remedies to collect money damages is well established in South Carolina law, according to the complaint. The complaint further states that the remedy of foreclosure is used to frighten the plaintiffs to settle their claims to avoid losing their homes.

The law firm defendants were accused of violating Professional Conduct Rule 3.3 by making deceitful arguments to courts. The law firms were also accused of demanding fees that are not proportionate to the hours devoted to the files in violation of Rule 1.5.

Threatening communications and pressure tactics are allegedly used to settle claims, typically without the advice of counsel because the amounts in controversy are often so small that the homeowners are unable to obtain legal counsel on a cost-effective basis. Typically, according to the complaint, holders of first mortgages are not named in the HOA foreclosures. The homeowners continue to be obligated to make their mortgage payments despite being evicted from their homes by their owners’ associations.

The first cause of action is violation of the Fair Debt Collection Practices Act on the theory that there is no right to use pre-suit liens or the equitable remedy of foreclosure by owners’ associations to collect damages in the form of past due assessments. The use of unjustified liens and foreclosures is alleged to constitute false, deceptive or misleading representations to collect debts.

The second cause of actions seeks a declaratory judgment that the activities of the defendants are unlawful. One point raised in this cause of action is that the homeowners are denied their statutory homestead exemption rights by the defendants’ actions.

The third cause of action is for intentional interference with the contractual relationship with the homeowners’ mortgage companies. The mortgage holders have a right to be named in actions that attempt to impair their interests in the subject properties, according to the complaint.

The complaint seeks actual, compensatory and consequential damages, in addition to punitive damages and attorneys’ fees. I can’t wait to see what happens with this one!

Did you hear the one about Katy Perry and the convent?

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It’s not a joke! It’s a true, real estate story!

Dirt lawyers, you know how your friendly title insurance underwriters are always harping about authority issues?  You have to carefully determine that the individuals with authority to sell or mortgage real estate are the individuals who actually sign the deeds and mortgages involved in your transactions.

katy perry nun

How do you solve a problem like Katy Perry?  (image from dailystar.co.uk)

And you know how the same friendly title insurance lawyers really harp about authority issues involving churches? Hardly a seminar goes by without the mention of a problematic closing or claim involving church property. I always say you should be particularly suspect if anyone, like a preacher, says he or she can act alone to sell or mortgage church property. Church transactions almost always involve multiple signatories.

Lawyers involved in transactions concerning church properties must ascertain whether the church is congregational, meaning it can act alone, or hierarchical, meaning a larger body at a conference, state or even national level must be involved in real estate transactions. In South Carolina, we have seen recent protracted litigation involving the Episcopal Church, making real estate transactions involving some of the loveliest and oldest church properties in our state problematic at best.

Lawyers must also determine, typically by reviewing church formation and authority documents, which individuals have authority to actually sign in behalf of the church. It is not at all unusual to find a church property titles in the names of long-deceased trustees.  It is always advisable to work with local underwriting counsel to resolve these thorny issues.

With that background, let’s dive into this Katy Perry story. The superstar decided to purchase an abandoned convent sitting on 8.5 acres in the beautiful Los Feliz neighborhood of Los Angeles for $14.5 million in 2015. Only five nuns were left in the order, The Sisters of the Most Holy and Immaculate Heart of the Blessed Virgin Mary. This order had previously occupied the convent for around forty years. Two of the nuns searched the web to find Katy Perry’s provocative videos and music and became uncomfortable with the sale. Instead, those two nuns, without proper authority, sold the property to a local businesswoman, Dana Hollister, for only $44,000 plus the promise to pay an additional $9.9 million in three years.

Proper authority for the sale should have involved Archdiocese Jose Gomez and the Vatican. Both were required to approve any sale of property valued at over $7.5 million. The Archdiocese believed Ms. Hollister took advantage of the nuns and brought suit. After a jury trial that lasted almost a month, the church and Ms. Perry were awarded $10 million on December 4. The jury found that that Ms. Hollister acted with malice to interfere with Perry’s purchase. Two thirds of the verdict are designated for the church and one third for Ms. Perry’s entity.

Assuming lawyers were involved in the Hollister closing, you would not want to be in their shoes! Always pay careful attention to authority issues in your real estate transactions. In South Carolina, real estate lawyers are in the best position to avoid problems like the ones in this story.

DOR issues new Revenue Ruling on Deed Recording Fees

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The South Carolina Department of Revenue issued Revenue Ruling #17-5 concerning Deed Recording Fees on August 28, 2017. This advisory ruling supersedes Revenue Ruling #15-3.

The new ruling is 39 pages long and covers the topic comprehensively in a question and answer format. This document is an excellent tool for lawyers with unusual transactions and for lawyers and paralegals who are new to the topic. The statutory scheme is set out in full, and the remainder of the document is stated to “summarize longstanding Department opinion concerning the taxability of these transactions.”

One question addressed how the deed recording fee should be paid when the real estate is located in more than one county. The answer cited Code §12-24-50 which requires an affidavit addressing the proportionate value in each county. The answer contained an example:

“For example, ABC Corporation sells realty, approximately 10 acres, to XYZ Corporation for $1,000,000. The realty is located in two counties, with 3 acres in County A and 7 acres in County B, However, because of the location of the 3 acres in County A (e.g., located at a major intersection, of the waterfront, etc.), the value of the 3 acres in County A is $700,000 while the value of the 7 acres in County B is $300,000.

Based on these values, 70% of the value is assigned to County A and both the state and county portions of the deed recording fee are paid in County A based on $700,000 consideration paid. (Total Fee Paid in County A: $2,590 ($1,820 State Fee and $770 County A Fee)). The remaining 30% of the value is assigned to County B and both the state and county portions of the deed recording fee are paid in County B based on $300,000 consideration paid (Total Fee Paid in County B: $1,110 ($780 State Fee and $330 County B Fee)).”

Another interesting* question addressed the method for correcting the mistake of recording a deed in the wrong county. (No one I know personally has ever had that problem.) Here’s the answer:

“Since the deed recording fee is actually a single fee composed of a state portion and a county portion, the entire fee must be paid when any deed is recorded with the county clerk of court or register of deeds.

Therefore, if a deed is recorded in the wrong county (e.g., a deed for realty in Lexington County is incorrectly recorded in Richland County), then the deed should be recorded in the correct county. The entire fee of “one dollar eighty-five cents for each five hundred dollars, or fractional part of five hundred dollars, of the realty’s value as determined by Section §12-24-30” should be paid in the correct county.

After recording the deed in the correct county, the person legally liable for the deed recording fee should then file a claim for the fee paid in the wrong county in accordance with the refund procedures for the deed recording fee established in SC Revenue Procedure #15-1. In addition to the information and documentation required in SC Revenue Procedure #15-1, the person filing the claim for refund should also provide the Department documentation that the deed has been recorded in the correct county. The Department will refund the state portion and order the county to refund the county portion.”**

Transfers to a spouse are exempt regardless of whether consideration is paid. Transfers to a former spouse are not exempt unless the transfers are made pursuant to the terms of a divorce decree or settlement. Query, why would anyone transfer real estate to a former spouse unless required to do so by a divorce decree or settlement?

This detail is provided to make the point of how comprehensive this document is and how helpful it might be in your practice. Take advantage of this guidance, particularly for lawyers and paralegals you need to train.

*You can measure how much of a dirt law nerd you are by how interesting you find this.

**They didn’t promise to make it easy.

Airbnb in Sea Pines?

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Court of Appeals says “yes” under some circumstances

I wouldn’t have predicted it, based on the history of exclusive Sea Pines Plantation in Hilton Head, its extensive set of restrictive covenants and the aggressive efforts to enforce those restrictive covenants over the years. But our Court of Appeals approved an owner’s rental through Airbnb of a portion of a residence in a December 6, 2017 case*.

Mr. and Mrs. Wall bought their residence at 48 Planters Wood Drive in 1998. The second story of the home consists of a guest suite that is accessible only by an outside staircase. In 2012, the Walls began renting a room through Airbnb, an online rental broker. The Airbnb listing was titled “Hilton Head Organic B&B, Sea Pines”. The Walls cooked breakfast for their renters.

AirBnB

Community Services Associates, Inc. (CSA), the property owners’ association in power to enforce Sea Pines’ restrictive covenants, expressed concern about the Airbnb listing, and the Walls changed the listing to the “Whole House” category and began renting out the entire first floor of their home while living in the second-story guest suite. They also dropped the “Hilton Head Organic B&B, Sea Pines” title and stopped cooking breakfast for their renters.

CSA filed suit seeking temporary and permanent injunctions against the Walls because of their alleged operation of a “bed and breakfast” in their home and the rental of less than the entire residence.

Here are the operative provisions of the restrictions:

  1. All lots in said Residential Areas shall be used for residential purposes exclusively, No structure, except as hereinafter provided, shall be erected, altered, placed or permitted to remain on any lot other than one (1) detached single dwelling not to exceed two (2) stories in height and one small one-story building that may include a detached private garage and/or servant’s quarters, provided the use of such dwelling or accessory building does not overcrowd the site and provided further that such building is not used for any activity normally conducted as a business. Such assessor building may not be constructed prior to the main building.

  2. A guest suite or like facility without a kitchen may be included as part of the main dwelling or accessory building, but such suite may not be rented or leased except as part of the entire premises, including the main dwelling, and provided, however, that such guest suite would not result in over-crowding of the site.

CSA took the position that the restrictions authorized the short-term rental of the entire residence but not part of the residence, that the Walls were operating an offending bed and breakfast, and that the guest suite included a second kitchen.

At a hearing before the master-in-equity, Mr. Wall testified that the couple kept an induction plate, a toaster oven, and a mini-refrigerator in the guest suite, and they occasionally prepared their food and washed their dishes in the suite.

The master denied the motion for injunctive relief and dismissed CSA’s complaint.

The Court of Appeals affirmed, stating that the dorm-style portable appliances used by the Walls did not create a kitchen. The Court held that the express terms of paragraph 6 require a residence with a guest suite to be rented in its entirety when the guest suite is rented out, but paragraphs 5 and 6 do not, by their express terms or by plain and unmistakable implication, require a residence with a guest suite to be rented in its entirety in every circumstance.

At best, according to the Court, paragraphs 5 and 6 are capable of two reasonable interpretations: (1) a residence with a guest suite must be rented in its entirety in every circumstance, or (2) the owners of a single family dwelling with a guest suite may stay in the guest suite themselves while renting out the remaining space. Because the latter interpretation least restrict the use of the property, the Court adopted that interpretation.

Understanding a little about the culture of Sea Pines, I will be surprised if we don’t hear more about this Airbnb issue in the future.

A recorded power of attorney may not be necessary to establish agency where real estate is involved

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In a recent South Carolina Court of Appeals case*, a mother was held to be bound by the actions of her wheeler-dealer son who appeared to act in her behalf buying and selling properties in Laurens County.

Frank Lollis lived with and took care of his mother, Kathleen Lollis, and managed real estate transactions for the family. The attorney who handled these transactions testified that he saw Frank sign his mother’s name and that he thought he recalled Frank showing him a power of attorney.

power of attorney

Lisa and Dennis Dutton, plaintiffs in this case, suing to enforce contracts Frank signed, testified that Frank had said he had a power of attorney. At trial, following Frank’s death, Mrs. Lollis denied the existence of the power of attorney.

Lisa Dutton testified that she had known Frank for nineteen years and had done a lot of real estate business with him and his family. She said that all of the locations where she had lived for the ten years prior to the trial were related to the Lollis family and every time she purchased property that was titled in Mrs. Lollis’ name, she dealt with Frank and his attorney. She said she “never had an issue” until she tried to obtain a deed to enforce a contract at issue in this case.

Frank’s attorney testified that Frank did a lot of his business in cash and always carried a lot of cash. Frank typically bought property in other individuals’ names and signed their names to documents, including not only his mother, but a former employee. The attorney signed an affidavit to the effect that Frank explained his “checkered past” required him to operate in the names of other individuals. The affidavit further stated that Mrs. Lollis knew Frank titled properties in her name.

Frank was diagnosed with cancer, and when he became increasingly ill, he asked his attorney to prepare a power of attorney for his mother naming his sister as the attorney-in-fact. After Frank’s death, the Duttons unsuccessfully attempted to obtain the deed to consummate the contract Frank had signed in his mother’s behalf. This lawsuit followed.

The case contains a detailed discussion of the law of agency in South Carolina. Real estate lawyers should know that their clients can become bound by their actions even in the absence of a recorded power of attorney because agency is a question of fact that does not necessarily depend upon an express appointment and acceptance.

An agency relationship is frequently implied or inferred from the words and conduct of the parties and the circumstances of the particular case. The Court of Appeals stated that agency may be proved circumstantially by the conduct of the purported agent exhibiting a pretense of authority with the knowledge of the principal.

The doctrine of apparent authority provides that the principal is bound by the acts of his agent when he has placed the agent in such a position that persons of ordinary prudence, reasonably knowledgeable with business usages and customs, are led to believe the agent has authority and they can deal with the agent based on that assumption.

This rule is based on public policy and convenience to provide safety for third parties.  In this case, the attorney testified that the mother was “fully aware that Frank was buying and selling property in her name” and was “transacting business in her name.” Lisa and her husband testified that Mrs. Lollis was present when they made some payments to Frank. Mrs. Lollis never objected and even retrieved the receipt book for Frank on a few occasions.

Lisa testified (1) Frank told her he had a power of attorney; (2) Lisa relied on Frank’s representation; and (3) she would not have entered into the contract and made payments had she known Mrs. Lollis would not acknowledge the existence of the contract. Dennis testified that (1) he believed Frank was acting on his mother’s behalf; (2) he relied on the course of dealing established in a number of transactions; and (3) if he had known Mrs. Lollis was not going to honor the contract, he would not have entered into it nor made payments.

The Court said that Mrs. Lollis’ knowledge that her son was buying and selling real estate in her name and her tacit acceptance of this practice placed Frank in such a position that the plaintiffs were led to believe he had the authority to act. The plaintiffs dealt with Frank based on that assumption. The preponderance of the evidence, according to the Court, shows an agency relationship between Mrs. Lollis and Frank as well as his apparent authority to sell. Frank’s actions were binding on his mother.

*Lollis v. Dutton, South Carolina Court of Appeals Opinion No. 5522 (November 1, 2017)

Reminder for dirt lawyers of a “secret lien” trap

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The sale of a majority of the assets of a business

Real estate lawyers despise unrecorded liens. I like to refer to them as secret liens. One such trap for the unwary dirt lawyer in South Carolina is the state tax lien imposed by Code §12-54-124. This statute was effective June 18, 2003, and I can vividly remember the day we first read it and scratched our heads about what it meant.

The statute reads:

“In the case of the transfer of a majority of the assets of a business, other than cash, whether through a sale, gift, devise, inheritance, liquidation, distribution, merger, consolidation, corporate reorganization, lease or otherwise, any tax generated by the business which was due on or before the date of any part of the transfer constitutes a lien against the assets in the hands of a purchaser, or any other transferee, until the taxes are paid. Whether a majority of the assets have been transferred is determined by the fair market value of the assets transferred, and not by the number of assets transferred. The department may not issue a license to continue the business to the transferee until all taxes due the State have been settled and paid and may revoke a license issued to the business in violation of this section.” (Emphasis added.)

That’s it! Very simple, but how are those terms defined?  What’s a business? Is a rental house in Pawleys Island a business?  How can a purchaser’s lawyer know whether taxes are due to South Carolina by the seller?  How can a purchaser’s lawyer know whether the sale of one Subway store is a sale of the majority of the assets of a franchisee’s business?

I had a friend and former law school professor who worked at the Department of Revenue at the time, so I called him and told him we were struggling with the meaning of the statute.  He gave me two very valuable pieces of information: (1) the terms in the statute are defined as the Internal Revenue Code defines them; and (2) the Department of Revenue (DOR) was likely to give us some guidance at some future date.

We struggled with the definitions in the Internal Revenue Code and finally decided that unless a property is an owner-occupied single family residence, the closing attorney should consider that it might be a business asset.

Thankfully, in 2004, the DOR did provide guidance in the form of Revenue Ruling 04-2. The Revenue Ruling stated that the code section does not apply if the purchaser receives a certificate of compliance from the DOR stating that all tax returns have been filed and all taxes generated by the business have been paid. The certificate of compliance is valid, according to the Revenue Ruling, if it is obtained no more than thirty days before the sale.

This Revenue Ruling also authorized attorneys to accept Transferor Affidavits, in the form promulgated by the DOR, when the transferor can state that the assets subject to the transfer are not business assets or are less than a majority of the transferor’s business assets, based on fair market value, in the current and other planned transfers.

house mousetrapThe Revenue Ruling addressed whether a vacation home is a “business” by stating that it is not a business if IRC §280A limits the deduction of vacation home rental expenses. That’s a little deep for dirt lawyers, so the safe approach is to always obtain a certificate of compliance or Transferor Affidavit when you close on that rental home in Pawleys Island.

I like to remind dirt lawyers that they are not tax lawyers (unless they ARE tax lawyers). Generally, when you represent a purchaser in a real estate transaction, do not give the seller tax advice on how to complete a Transferor Affidavit.