Think twice before ‘walking away’ from investment property

Consider Starker exchange, land-sales contract for dilapidated rental

DEAR BENNY: I currently own a single-family rental house in suburban Chicago. I have long-term tenants, and the house needs quite a bit of updates and improvements.

Because of the high taxes, the cost of upkeep and maintenance and in general, the climate of the real estate industry, I’d like to dispose of the property. Unfortunately, selling the house is not a realistic option because houses in the area remain on the market for many months and even years, and I figure that I’d have to "dump" a ton of money into the property in order to make it presentable and pass the rigid home inspection policies of the city, prior to selling.

Therefore, I’d like to entertain the ideas of either demolishing the property and donating the land to the city or just "giving" or deeding the property to the current tenants and walking away (there is no mortgage on the property). I’ve offered to sell the property to the tenants, but they have bad credit and no money.

Are these viable options? What are the legal implications of each option? –Raul

DEAR RAUL: You have a house free and clear, and it is an investment property. Before you do anything drastic, I would discuss your situation with a tax professional.

There are many, many options. You can sell it for whatever you can get and take a loss (confirm this with your accountant). I suspect that despite the city requirements, you still have the right to sell your property "as is." You can donate it to a charity and again take a tax deduction. You can do a Starker (Section 1031) exchange and end up with a better property. And despite the bad credit of your tenants, you can arrange for a land-sales contract, whereby they start making monthly payments toward the purchase and at some point in time you give them the deed to the property. If they don’t make the payments, they are in default and you still have the property. This will require your attorney to assist you with the concept and its implementation.

I cannot see any benefit of spending the money to tear it down when there are plenty of other options.

DEAR BENNY: I’m writing because I need to consult with an attorney on what would happen in the event that I walked away from an underwater property.

In 2005 I invested in real estate in and around Wilmington, N.C. The area was experiencing the boom like everywhere else. I built and acquired townhouses at the beach and also a patio home where my stepdaughter lived while she was in college.

I did not sell the investment properties when I should have, which was at the top of the market in 2006-2007. But we still have them, and one property in particular is not likely to regain value anytime soon.

The other homes are rented and have sufficient rental income to make them worth holding on to until the market improves.

My husband and I were advised by our financial planners/ financial management firm to consider walking away from this property — it is a lot, one that I intended to build on. –Barbara

DEAR BARBARA: When your financial advisers recommended that you walk away from the vacant lot, did they tell you the pros and cons of such a move? If not, you should immediately terminate them.

Let me address this from two different scenarios:

1. The vacant lot is encumbered with a mortgage: If you walk away, your lender could ultimately foreclose on the lot. If the lot does not generate enough money to pay off the existing loan (which is usually the case), depending on your state law, the lender could go after you and your other assets for the deficiency.

And even if your state prohibits deficiency judgments (which a few states do), instead of foreclosing, the lender could file suit against you based on the promissory note that you signed. Then, once it has a valid judgment, it could garnish your wages, and attach your other assets.

2. The vacant lot is free and clear. This is a little less risky if you choose to walk away. Ultimately, the city/county where the property is located will sell it for nonpayment of real estate taxes.

But before you go down that path, have you — and your financial advisers — considered other alternative options? If there is a mortgage, ask the lender if it will take back the property by way of a "deed in lieu." This means the lender will get the property directly "in lieu" (instead) of a foreclosure.

If there is no mortgage, have you considered donating it to a charity so that you may be able to get a tax deduction? Have you considered selling it for whatever the market can bring? Because this was probably not considered "investment property" you probably won’t be able to take a tax loss on any sale, but confirm this with your own tax advisers.

What about your neighbors? Perhaps they would like to have a lot adjacent to their property for future growth? I have had a number of clients who sold directly to their neighbors, thereby not having to pay a real estate commission.

And in the final analysis, is there any merit in hanging in there for the foreseeable future? I cannot guarantee anything — and my two crystal balls are shattered — but I do believe we are on the road to recovery. You will kick yourself for a long time if the market picks up and you have already divested yourself of that vacant lot.

DEAR BENNY: In December 2007 I purchased a one-bedroom unit on the top floor in a mixed-income development. Nearly seven months ago, management ran a water test on the roof that resulted in water flowing into my unit, as well as both structural and personal damage to my ceiling and possessions.

I am a board member and I’m really concerned because I’ve been told that both categories of damages are my responsibility.

If management and the developer can dismiss me with such disregard, I can imagine how other homeowners would be treated under similar circumstances. Nothing about the water test was my doing; it was a deliberate test, ordered by management, in response to complaints of water leaks in other units.

What is my remedy? Should we still be paying master dues? –Elaine

DEAR ELAINE: Pardon me while I vent about a topic of great concern to me, namely the relationship between a property manager (or company) and the board of directors.

When a landlord rents his property and uses a property manager, he wants only the bottom line: What’s the monthly cash flow? The manager handles all of the details using his discretion.

But in a community association, it should be the reverse: The board provides the guidance and the orders, and the manager faithfully follows through.

So, in your case, the decision is not the property manager’s to make; it is the board that makes that decision based on the facts, and on the recommendations and opinions of the association’s attorney and insurance agent.

Does the association have legal counsel? If not, you should. Plus, that attorney should be independent of the property manager. Also, if the board makes a decision, because this involves your unit you should recuse yourself from any vote, and have the minutes reflect this for your protection.

I cannot provide a legal opinion without knowing all of the facts, but if the leak occurred while doing a roof-leak test, common sense tells me that the problem is in the common elements and not in your unit.

Do you have HO-6 insurance coverage? That’s insurance to cover problems in your unit that are not covered by the master insurance. If you do have it, contact your insurance agent; he or she will be helpful in determining the cause of the leak. If you do not have that insurance, I strongly recommend that you get it immediately.

As for your master dues question, this also should be responded by your association counsel. However, the answer may also be found in your association legal documents.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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