Episode 106: What is Escrow?

Earnest money contracts to buy real estate are something every buyer and seller should be familiar with. Although most are familiar with a one to four-family residential contract, there are those that can also be put together for farms, ranches, commercial office buildings, commercial properties, and industrial properties. Regardless of the type of property, it can be advantageous to enlist the help of a reputable and knowledgeable real estate attorney to assist with the different components of earnest money contracts.

How Earnest Money Works

Earnest money is typically put down in the form of a check that is paid to the title company to hold on to until the transaction terminates or is fulfilled. However, it is worth noting that there are forfeiture provisions that can go into effect if certain things do not happen. If the property is not closed upon, the buyer is at risk of losing their earnest money. A real estate attorney may be helpful in dealing with a more complex escrow situation.

More recently, a termination option has become available in which a buyer will pay a fixed amount of money in markets that are considered a buyer’s market, in which there is a great deal of product available. These options are usually low numbers of approximately $100, $200, or $500 and allow the buyer the option to terminate if they see something they do not like or for no particular reason. In this case, the buyer forfeits their termination fee which the seller keeps, but the buyer typically wants the rest of their earnest money back.

However, at present, there is a much tighter market with not a lot of product, so some of these termination provisions are at a much higher number that buyers are putting up in order to more effectively attract a seller. It may even be possible for the buyer to waive their termination option entirely to make themselves more competitive in attracting a seller. A buyer’s higher termination option number or waiver may make them stand out from all the other bidders and make a seller more likely to accept their contract.

The Role the Title Company Plays in Earnest Money Contracts

Most of the time the title insurance company gets involved in the process. The purpose of a title insurance company is:

  • To go through the process to make sure that the seller has a good title
  • To ensure there are no liens
  • To determine that the borders are properly defined
  • To make certain there are no easements or judgments that affect the property

This process is in place so that a buyer knows that they actually are buying the property and there are not expected to be any legal problems that come up afterward. However, should there be legal problems that crop up afterward, there is an insurance policy that will help pay the cost of fixing that property or paying the damages caused by the title problem. The seller typically pays for the title policy, but it is an option for the buyer to pay for it.

The title company generally takes over the process of closing. They will get a title report out showing liens, easements, problems that exist, and whether or not they get eliminated or it is just something the buyer has to understand.

The title company will provide that report and work out whatever needs to be worked out regarding that and makes sure that any liens, taxes, or homeowners association dues that are outstanding are paid at closing.

Usually, the buyer’s money (or lender’s money) goes to the title company who will then pay the taxes and the former mortgage company and any other liens necessary to clean it up and then disperse the excess monies (if any) to the seller.

Surveys and Inspections as Related to Earnest Money Contracts

Typically, when buying a home, a survey is done. In cases where there are lots, blocks, and subdivisions, it is typically not that difficult to do. Farms, ranches, and places with larger acreages can be a different story.

There are also usually inspections where the buyer will send an inspector in to make sure of things such as whether the plumbing works and that the roof and foundation are good and that there are no mechanical or physical problems with the home.

There are survey reports and inspection reports. Generally speaking, the buyer has an opportunity to object to those things and either require an allowance to fix those things or require a seller to fix them before closing. Once those objections are resolved and the financing is set up, the title company can conduct a closing.

The Real Estate Closing Process

The buyer’s lender (usually a mortgage company, bank, or third-party lender) will want to have a valid first lien on the property. For this reason, the mortgage company will get involved and look at the survey and the title report to make sure they are getting a clean first lien on a property that is going to have value.

An appraisal is also typically done to make sure the property is worth enough to support the loan. Sometimes there can be problems with appraisals, although not as much recently because values have gone up. In tighter markets, you may have a contract for a $300,000 house that only appraises for $280,000, which means the borrower may not be able to close.

There are provisions and contracts that can give a buyer the option to get out of a contract if they do not meet the financial requirements. However, in the current market, some buyers are waiving that to be more attractive to sellers.

The closing date is a key provision in an earnest money contract.  It generally sets the date at which the buyer must either buy or be in default of the contract. Sometimes there may be extensions granted voluntarily if an inspection is taking too long or there is some other reason a closing is delayed, but everybody still wants to get the deal done. There are forms a realtor can distribute to the buyer and seller to extend that date.

Ultimately there is a date at which the transaction needs to take place or the buyer will be in default. Or, if the buyer shows up and the seller wants out, the seller could be in default. After the closing takes place, the seller will turn possession over to the buyer.  This basically means giving them the keys and having the seller move their stuff out if they have not already.

Are Earnest Money Contracts Enforceable?

When done properly, an earnest money contract is enforceable.

There can be lawsuits for defaults on earnest money contracts. However, be forewarned that it ties up the property and can be expensive. It is often difficult for a seller to enforce a contract against a buyer just because they can sue them for damages (generally what it costs the seller to find a new buyer, the difference in price, and the carrying cost of the property going forward).

Even if there ends up being a judgment against a potential buyer, that judgment may or may not be collectible. At times, these things can fall out because the buyer did not have enough money to do the deal, and maybe not enough money to pay the judgment of the lawsuit. There are situations where there may be a wealthy enough buyer willing to pay money to get out of the contract and would have some problems with having a lawsuit and getting a judgment against them that they would rather pay some sort of compensation to the seller for the seller’s loss in connection with a broken earnest money contract.

On the flip side, a buyer who wants to enforce a contract against a seller that wrongfully backs out of a contract may have a better choice of remedies. The seller has the property, a lawsuit can be filed, and a lis pendens can be filed in the real property record, which lets the world know that the title to that property is the subject matter of a lawsuit, and whoever buys the property from the seller is taking it subject to the rights of the lis pendens holder, or the potential buyer in this example.

One caveat to the notion that a buyer can sue the seller and recover something is that if the seller has a large mortgage on the property, then there may not be much the seller can do because the mortgage company would likely foreclose on the property, wiping out the interest the seller had, leaving little money for the buyer to collect from the seller. This type of situation is not good for the buyer.

How To Handle Property Damage and Taxes

How To Handle Property Damage and Taxes

If you own a business and it suffered from damage due to a flood, fire, or an accident, it is wise to visit with a tax attorney about property damage and taxes and the possible correlation between the two. Depending on the value of an item and the insurance coverage for it, it may be possible for a business to experience a gain for a casualty loss. This gain is then taxable, but by enlisting the help of a knowledgeable attorney who has an intimate understanding of business and tax law, there may be opportunities to minimize that taxable income.

Claiming Business Property Damage

One of the first steps in claiming property damage is to file the IRS Form 4684 regarding casualties and thefts. In terms of federal income tax purposes, casualties are typically defined as an unexpected or sudden damage or loss of property. This generally covers natural disasters such as hurricanes, floods, tornadoes and earthquakes, but may also cover other specific scenarios as well.

As for determining what business property is worth, it comes down to estimating its adjusted tax basis immediately before the loss, minus its salvage value. In other words, calculate what the cost of acquiring and improving the item was and then subtract depreciation deductions. Then subtract the amount the property is worth post-casualty.

If casualties caused business property to be destroyed, the business may want to see about claiming a deduction for it. This, however, requires the claiming party to prove:

  • Ownership of the property
  • Amount of basis in the property
  • Pre-casualty value of the property
  • Reduction of value caused by casualty
  • Inability of reimbursement to cover costs

These safeguards have been put in place to better prevent abuse of the system.

Deducting Casualty Losses

According to the Internal Revenue Service, casualty losses may be deductible, but only in the year of the event that caused the loss. It is worth noting that something is not considered a loss if it could potentially be recovered through a reimbursement claim.

If a casualty loss is the result of a federally declared disaster, this situation can come with more specific guidelines about when to deduct that property on your taxes.

Property Damage and Taxes: Losses Could Result in Taxable Gains

What some business owners may not realize is that with insurance reimbursements, it could be possible to receive more than the adjusted basis of damaged property, and that can result in a taxable gain.

However, some gains are eligible to be deferred only if certain replacement property is purchased. For this to work, replacement property must generally be purchased within two years of the tax year that the gain occurred.

In a situation where a loss deduction exceeds your income, it may result in an NOL, or net operating loss, for that year. Essentially NOLs may help minimize taxes for a previous tax year which could in turn yield a tax refund. In order for a business to see if this is a scenario that is applicable to them, it is wise to first seek the counsel of an attorney that has a business and tax background. They can assist with determining eligibility.

Minimizing Taxable Income from Casualty Loss Insurance Recoveries

When it comes to the loss of business property, considering the fact that a business might get a taxable gain back can be the furthest thing from an owner’s mind. Still, if not strategic about handling that gain, it may end up being taxable instead, which can be like adding insult to injury.

A reputable tax attorney should be familiar with ways to potentially minimize or eliminate taxable gains as the result of casualty losses. One of the most frequently utilized options has to do with reinvesting. Federal tax rules may allow businesses with a taxable gain to minimize or reduce it by reinvesting the insurance money in what is commonly defined as “similar use” property.

Consider the two following scenarios:

  1. A company purchases a vehicle for a certain price. Some years later said vehicle is totaled and is assigned a depreciated tax basis. If the insurance company reimburses the company at a rate higher than the depreciated tax basis, that amount is considered taxable.
  2. In the same situation, if the company decides to reinvest that taxable amount into a replacement vehicle, it is not necessarily required to report the taxable gain as long as certain conditions are met.

Most businesses would prefer to be in the second situation so that they are able to replace what they lost and are not being taxed for a gain, but for this to work it can take a skilled tax attorney to ensure that it is marked correctly on the business’ tax return. The process can be quite complex with a number of guidelines and specifications that must be met.

For example, in general, the replacement property for reinvestments is two years. It may not be valid after the fact, although there may be some limited exceptions offered by the Internal Revenue Service in certain situations.

What to Look for in a Tax Attorney for Your Business

Tax attorneys should have a background in working with businesses on matters like the above, but it is equally important to make sure that the attorney you hire meets several qualifications, such as:

  • Experience. It is critical to hire an attorney who has specific knowledge and understanding of business tax matters. Verify how many business tax cases they have taken, what they involved, and the outcomes of each.
  • Knowledge. In addition to being certified to practice law in Texas, an attorney should have extensive knowledge of federal and state tax laws. It is also important that legal counsel stay up to date on these mandates as they can change periodically and may significantly impact a business’ bottom line.
  • Representation. In the event that a dispute arises, it is necessary that the attorney hired can represent your business in a court of law.

Don’t let ill-managed property damage and taxes unnecessarily cost your business. Enlist the help of a trusted tax attorney today and determine your options on properly handling a loss.

Fraudulent Conveyance or Fraudulent Transfers Suicide

Suicide is never an easy topic to discuss, especially as it relates to legal matters such as fraudulent conveyance. Taking one’s own life is a decidedly tragic event that adversely impacts the deceased’s family, friends, and even community. In addition to the heartache of losing someone to suicide, those survived by the individual often do not realize that the legal consequences related to the act can go on long after.

Learning more about a fraudulent transfer and how it relates to the Uniform Fraudulent Transfer Act may help survivors better understand the legal processes that can follow a suicide.

Understanding Fraudulent Transfers

A fraudulent transfer happens when an individual that has money or property and is about to lose that property due to some sort of judgment or creditor then transfers said property to another party. This may be done so that if a judgment or creditor tries to collect from the transferor, there is no property left to collect on.

The law recognizes this act as unjust and generally allows a creditor to proceed against the recipient of a fraudulent transfer to recover one of two things:

  1. The property that was transferred
  2. Judgment for the value of the property

Uniform Fraudulent Transfer Act

As many other states do, the state of Texas follows the Uniform Fraudulent Transfer Act. This act sets forth the circumstances and establishes the rules to be followed when analyzing if a transfer of money or property is subject to it.

There are two prongs to the Uniform Fraudulent Transfer Act including:

  1. Actual Intent
  2. Constructive Fraud

Breaking Down Actual Intent as It Relates to the Uniform Fraudulent Transfer Act

For the actual intent prong of the act, if a transferor transfers property to another individual with the express intent to hinder, delay, or defraud the transferor’s creditors it is typically considered to be a fraudulent transfer.

Actual intent may be hard for a creditor to prove as the circumstances might or might not permit a jury or judge to determine that the transferor had such intent. Factors that can be taken into consideration in determining intent are:

  • A transfer was made to an insider or related party
  • The debtor or transferor retains possession or control of the property after the transfer
  • A transfer or obligation was concealed in what is viewed as a secret manner
  • An obligation by the transferor was incurred or the transferor had been sued or threatened with a lawsuit before a transfer was made
  • The transfer was substantially all of the debtor or transferor’s assets
  • The debtor or transferor removed or concealed assets
  • The amount of consideration received by the transferor was not of reasonable equivalent value
  • The transferor was insolvent or became insolvent as a result of the transfer

Constructive Fraud and the Uniform Fraudulent Transfer Act

In the event that a creditor cannot establish the actual intent prong of the act, the constructive fraud prong of the act comes into play. Of the two prongs, constructive fraud is usually easier to prove as all that is necessary is to show the following:

  • There was a transfer
  • The transfer was made at the time that the debtor or transferor was insolvent
  • The transfer was for less than an equivalent value in exchange for the transfer

Fraudulent Transfer Act and Suicide Case Study #1

With the knowledge of what a fraudulent transfer is and how the Fraudulent Transfer Act would come into play, it may be easier to understand how the unfortunate incident of suicide might invoke the act.

The following case study may help the reader to make better sense of this connection, however, please be forewarned that the following is tragic and somewhat gruesome and may not be appropriate for all audiences.

In this example, a husband and wife are going through an intensely contentious divorce. Amidst the divorce, the husband returns to his marital home to gather some of his belongings. In doing so, he gets into a confrontation with the wife and violence ensues, ending with the husband shooting and killing his wife before turning the gun on himself in an act of suicide.

The husband had a long-standing relationship with a girlfriend. After the separation from his wife, he and his girlfriend opened a joint bank account that had a balance of approximately half of a million dollars at the time of his death. The husband did have some credit card debt and other small creditors and essentially his entire fortune consisted of half a million dollars in the joint bank account with his girlfriend. That bank account was considered to be a joint tenancy with right of survivorship meaning that if the man died, his girlfriend and co-bank account holder would receive the money.

However, when the husband took his wife’s life, he became indebted to the wife’s estate for wrongful death. Now, at that time, there had been no transfer yet as the money was still in the account the husband and girlfriend jointly controlled.

Yet, when the husband decided to take his own life, his interests in that bank account would have transferred to the girlfriend due to the survivorship nature of the account.

In this case, a lawsuit was quickly filed and the court froze the bank account with an injunction against the distribution of the money. At a later date, a compromise was eventually reached by splitting the money between the estate of the wife and the girlfriend.

In this specific example, it is fairly clear that the suicide was in fact a fraudulent conveyance.

Fraudulent Transfer Act and Suicide Case Study #2

As with the above, the following case study may not be appropriate for all readers. It should however help the reader to better understand the connection of the Fraudulent Transfer Act to suicide.

In this second case study, a man who admittedly had many mental problems transferred the entire contents of his bank account, which was one million dollars, to his sister on Wednesday. On Thursday, the sister discovers the funds and is confused, so she tries to get in touch with her brother. She is unable to reach him and since she lives in a different city than the brother, she cannot go immediately to check on him.

In the meantime, a neighbor goes to check on the brother. At the moment the neighbor knocks on the door, the brother had just completed writing his suicide note. After hearing the knocking, the brother shoots three bullets through the door injuring the neighbor. The brother then takes his own life by suicide.

The neighbor eventually sues the sister alleging she is the recipient of a fraudulent conveyance or transfer. The brother had no debts and still owned some property even after he transferred the money to his sister, making him decidedly not insolvent. Therefore, this lack of insolvency does not satisfy the constructive fraud prong of the Fraudulent Conveyance Act.

At the time the brother transferred the money, it preceded the actual injury to the neighbor. The transfer happened before the liability or intentional and negligent act which injured the neighbor occurred. Therefore, the neighbor tried to invoke the actual intent prong of the act to force the sister to return the one million dollars.

The invocation of the prong was not successful because the neighbor needed to prove the brother had the actual intent to occur debt. While there was sufficient evidence the brother planned to commit suicide when he made the monetary transfer to his sister, there was little evidence to suggest he intended to incur any other debt including the injury to the neighbor, which seemed to be more of a consequence of unfortunate timing.

In the end, the neighbor accepted a settlement for a relatively token amount of money, the case was resolved, and the sister managed to keep most of the money her brother transferred to her.

Suicide is a delicate subject that is seldom easy to discuss, but it does create real legal issues that can cause conflict between the recipient of a transfer and those who might try to collect a judgment or claim against the deceased party who made the transfer.