UPDATE: On December 7, 2024 FinCEN issued the following ALERT UPDATE regarding enforcement of the Corporate Transparency Act:

“On Tuesday, December 3, 2024, in the case of Texas Top Cop Shop, Inc., et al. v. Garland, et al., No. 4:24-cv-00478 (E.D. Tex.), a federal district court in the Eastern District of Texas, Sherman Division, issued an order granting a nationwide preliminary injunction that: (1) enjoins the CTA, including enforcement of that statute and regulations implementing its beneficial ownership information reporting requirements, and, specifically, (2) stays all deadlines to comply with the CTA’s reporting requirements. The Department of Justice, on behalf of the Department of the Treasury, filed a Notice of Appeal on December 5, 2024.

Texas Top Cop Shop is only one of several cases in which plaintiffs have challenged the CTA that are pending before courts around the country. Several district courts have denied requests to enjoin the CTA, ruling in favor of the Department of the Treasury. The government continues to believe—consistent with the conclusions of the U.S. District Courts for the Eastern District of Virginia and the District of Oregon—that the CTA is constitutional.

While this litigation is ongoing, FinCEN will comply with the order issued by the U.S. District Court for the Eastern District of Texas for as long as it remains in effect. Therefore, reporting companies are not currently required to file their beneficial ownership information with FinCEN and will not be subject to liability if they fail to do so while the preliminary injunction remains in effect. Nevertheless, reporting companies may continue to voluntarily submit beneficial ownership information reports.”

CONTINUED MONITORING IS ADVISED. If you choose not to submit a beneficial ownership information (“BOI”) report at this time, it is recommended that the required information be compiled internally in case the injunction is lifted, requiring compliance in the future.

Corporate Transparency Act Compliance – Obtain your FinCEN ID NOW

The Corporate Transparency Act (“Transparency Act”) is a new federal law that went into effect on January 1, 2024.  It applies to most privately held companies (each, a “reporting company”)[i], especially those typically used for commercial real estate investment and most small businesses. There are exceptions but they are limited. Failure to comply exposes you to fines and criminal liability, including possible jail time.

            The Transparency Act is administered and enforced by the U.S. Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Its aim is to curtail money laundering and other illegal activities.

Beneficial Owners

            To comply, each reporting company must file with FinCEN a written disclosure of all “beneficial owners” having a direct or indirect interest in the company.  Beneficial owners are those individuals who (a) exercise “substantial control” over the entity, or (b) own or control at least 25% of the ownership interests in the entity.

Substantial control

“Substantial control” is very broadly defined to include any individual who (i) serves as senior officer of a reporting company; (ii) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body) of a reporting company; (iii) directs, determines, or has substantial influence over important decisions made by the reporting company (functional or de facto authority); or (iv) has any other form of substantial control over the reporting company. Examples of individuals who are deemed to exercise “substantial control” include but are not limited to: c-suite officers of a corporation including any individual who holds the position of general counsel; managers of a limited liability company, trustees of a trust, and general partners of a limited partnership, to name a few

Beneficial Ownership Information Report

Each reporting company is required to timely file with FinCEN a Beneficial Ownership Information Report (BOI Report) containing all necessary information. A parent company is not authorized to combine affiliated companies into a single BOI Report. Each and every reporting company must file a separate BOI Report. 

In light of the legal exposure to fines and jail time, it is prudent to overreport rather than underreport to assure full compliance with the Transparency Act.

Deadline for Reporting:

For reporting companies formed prior to January 1, 2024, the reporting deadline is December 31, 2024. For reporting companies formed on or after January 1, 2024 but prior to January 1, 2025, the reporting deadline is ninety (90) days after formation. For reporting companies formed on or after January 1, 2025, the reporting deadline is thirty (30) days after formation.  A BOI Report needs to be filed only once except that if, after filing any initial BOI Report, any of the information in the BOI Report changes, the BOI Report must be timely updated.

BOI Report Contents:

Each BOI Report must be filed with FinCEN electronically using FinCENs’ Beneficial Ownership Secure System (“BOSS”). The BOI Report must include precise information about the reporting company and its beneficial owners. The information for each reporting company must include, without limitation, the following: the full legal name and any alternate or assumed name of the reporting company; its jurisdiction of formation; current U.S. address; Tax ID number; and a description and copy of an acceptable identifying document. 

IN ADDITION, each BOI Report must include detailed Beneficial Owner Information including (A) the individual’s last name (or if the beneficial owner is an entity, the entity’s legal name); first name, date of birth, current residence address, a description and copy of an acceptable form of identification, which may include the photo page of a current passport, state issued driver’s license (front and back) or other government issued photo ID (front and back); or (B) the beneficial owner’s FinCEN Identifier (“FinCEN ID).  

FinCEN Identifier (FinCEN ID):

It is common for investors to be a beneficial owner of more than one reporting company. Since identifying information for each beneficial owner must be included in each BOI Report, repeatedly providing your detailed Beneficial Owner Information for successive BOI Reports may prove cumbersome and redundant. You may also be concerned about providing your Beneficial Owner Information to others. There is a solution.

Instead of repeatedly providing all required Beneficial Owner Information and documentation to each reporting company for each BOI Report, you can file it once with FinCEN and obtain a FinCEN Identifier, which is a unique 12-digit number issued by FinCEN which matches your Beneficial Owner Information to your information in the FinCEN database. The FinCEN database is designed to be confidential and secure, with highly restricted access. Thereafter, whenever a BOI Report is required to be filed, you may simply provide your FinCEN Identifier in lieu of detailed personal identifying information and documentation.

Obtaining a FinCEN Identifier is easy. Go to: http://fincenid.fincen.gov  then click on the Sign In or Create an Account button and follow the instructions.  Alternatively, simply Google: How to obtain FinCEN ID and then follow the step-by-step instructions.

Don’t delay. The clock is ticking.

[i] As of March 11, 2024, FinCEN has posted an Updated Notice concerning a lawsuit entitled National Small Business Untied v. Yellen, No. 5:22-cv-01448 (N.D. Ala.) where a federal district court entered a final declaratory judgment concluding that the Corporate Transparency Act exceeds the Constitutions’ limits on the powers of Congress and enjoining the Department of Treasury and FinCEN from enforcing the Corporate Transparency Act against the plaintiffs. The Justice Department, on behalf of the Department of Treasury filed a Notice of Appeal on March 11, 2024. While the litigation is ongoing, FinCEN will continue to implement the Corporate Transparency Act as required by Congress, while complying with the courts order. For more information go to:  https://www.fincen.gov/news/news-releases/updated-notice-regarding-national-small-business-united-v-yellen-no-522-cv-01448

Synopsis:

An Illinois landlord under a commercial lease must take reasonable measures to mitigate damages,

. . . but only if mitigation of damages is required – which is not always.

The General Duty to Mitigate

      Illinois landlords and their agents are required to use reasonable measures to mitigate damages recoverable against a defaulting lessee. 735 ILCS 5/9-213.1. The term “reasonable measures” is not defined by statute, and Illinois courts have held that whether the landlord has complied with the reasonable-measures standard is a question of fact, to be determined on a case-by-case basis. Danada Square, LLC v. KFC National Management Co., 392 Ill.App.3d 598, 913 N.E.2d 33, 41, 332 Ill.Dec. 438 (2d Dist. 2009).

      Section 9-213.1 of the Code of Civil Procedure, 735 ILCS 5/1-101, et seq., is mandatory, however, and it is the responsibility of the landlord, when proving damages, to also prove that it took reasonable measures to mitigate damages, whether or not the landlord’s requirement to mitigate damages was raised as an affirmative defense by the tenant. St. George Chicago, Inc. v. George J. Murges & Associates, Ltd., 296 Ill.App.3d 285, 695 N.E.2d 503, 508 – 509, 230 Ill.Dec. 1013 (1st Dist. 1998); Snyder v. Ambrose, 266 Ill.App.3d 163, 639 N.E.2d 639, 640 – 641, 203 Ill.Dec. 319 (2d Dist. 1994).

      The landlord has the burden to prove mitigation of damages as a prerequisite to recovery. Snyder, supra, 639 N.E.2d at 641; St. Louis North Joint Venture v. P & L Enterprises, Inc., 116 F.3d 262, 265 (7th Cir. 1997). Losses that are reasonably avoidable are not recoverable. Nancy’s Home of Stuffed Pizza, Inc. v. Cirrincione, 144 Ill.App.3d 934, 494 N.E.2d 795, 800; 98 Ill.Dec. 673 (1st Dist. 1986); Culligan Rock River Water Conditioning Co. v. Gearhart, 111 Ill.App.3d 254, 443 N.E.2d 1065, 1068, 66 Ill.Dec. 902 (2d Dist. 1982).

      In dicta, the court in St. George, supra, stated that failure to take reasonable measures to mitigate damages may not necessarily bar recovery by the landlord, but it will result in the landlord’s recovery being reduced. 695 N.E.2d at 509. How this would work from an evidentiary standpoint, however, is not entirely clear. Presumably, the landlord could introduce evidence at trial that, although the landlord did not take reasonable measures to mitigate damages, if it had, damages would have been reduced by some specified amount. If the landlord fails to introduce even that evidence, however, the question appears to remain open as to whether the landlord adequately proved damages — since the burden of proof of damages remains with the landlord and there is no suggestion that the statutory requirement to prove mitigation shifts to the tenant.

      At least one recent case has, in dicta, questioned aspects of both St. George and Snyder, supra, disagreeing that proof of mitigation must be demonstrated by the landlord as a prerequisite to recovering damages and has suggested that the issue of mitigation of damages is an affirmative defense that must be raised by the tenant, or it is waived. Takiff Properties Group Ltd. #2 v. GTI Life, Inc., 2018 IL App (1st) 171477, ¶23; 124 N.E.3d 11; 429 Ill.Dec. 242.

      Further, as a matter of first impression, the court in Takiff went on hold that the landlord’s obligation to mitigate can be contractually waived by a commercial tenant Takiff, at ¶29, and, as determined by the trial court, was in fact contractually waived by the tenant, rendering the issue of mitigation moot. 2018 IL App (1st) 171477 at ¶31.

      Possession as a Condition Precedent to Landlord’s Duty to Mitigate.

      Notwithstanding any general duty of landlord to mitigate damages, a landlord has no duty to mitigate until the landlord comes into possession. 2460-68 Clark LLC v. Chopo Chicken, LLC, 2022 IL App (1st) 210119, ¶34; Block 418, LLC v. Uni-Tel Communications Group, Inc.  398 Ill.App.3d 586, 925 N.E.2d 253, 258 ((Ill. App. 2 Dist. 2010); St. George Chicago, Inc. v. George J. Murges & Associates, Ltd., 296 Ill.App.3d at 290-91.

      Discussing the application of this principal, the Chopo Chicken court noted that an eviction proceeding is a summary proceeding to recover possession. Since a landlord has no duty to mitigate until the landlord is in possession, and, in an eviction action, a landlord is not in possession until the eviction court grants the landlord an order of possession and landlord recovers possession, landlord’s efforts to mitigate, or the lack thereof, are not relevant.  Chopo Chicken, supra ¶34

      Liquidated Damages Provision Makes Mitigation Irrelevant. 

      It is the general rule in Illinois that, in the case of an enforceable liquidated damages provision, mitigation is irrelevant and should not be considered in assessing damages. Chopo Chicken at ¶33. A liquidated damages provision is an agreement by the parties as to the amount of damages that must be paid in the event of default. Chopo Chicken at ¶33. Liquidated damages in commercial leases are not uncommon.

      In Chopo Chicken, the court considered a provision that included an itemization of damages recoverable by landlord from tenant including “a sum equal to the amount of unpaid rent and other charges and adjustments called for herein for the balance of the term hereof, which sum shall be due to Landlord as damages by reason of Tenant’s default hereunder” which, the court found, constituted a liquidated damages provision. 

      Similarly, in the St. George case, 296 Ill.App.3d 285; 695 N.E.2d 503, 507 the court found that a so-called “rent differential” formula (i.e. amount determined by the excess if any of the present value of the aggregate Monthly Base Rent and Operating Expense Adjustments for the remainder of the Term as then in effect over the then present value of aggregate fair rental value of the Premises for the balance of the Term the present value calculated in each case at 3%) constituted a liquidated damages provision.

            The Summary Rule regarding Mitigation

      Based upon the foregoing cases, the actual Illinois rule governing mitigation of damages in commercial lease disputes appears to be as follows: A landlord must take reasonable measures to mitigate damages, if mitigation of damages is required – but mitigation of damages is not required (i) until the landlord is placed in possession of the leased premises, or (ii) when the lease includes a liquidated damages provision.

On March 18, 2022, the Illinois Appellate Court issued its first opinion addressing efforts by a commercial tenant to escape liability under its lease by reason of the COVID-19 pandemic.  55 Jackson Acquisitions, LLC v. Roti Restaurants, LLC, 2022 IL App (1st) 210138 is lengthy, factually detailed, and instructive. It is useful because it lays out the issues to be considered when the doctrines of impossibility, impracticability, and frustration of purpose are interposed as defenses to commercial lease enforcement.

The facts are not unusual for COVID era lease disputes.

Landlord and tenant entered into a multi-year commercial lease commencing on January 1, 2017 for the operation of a restaurant to sell “food for on and off premises consumption, including the sale of beer, liquor and wine, and ancillary items and uses found in other Roti establishments.”  The lease obligates tenant to conduct and operate its business in a “proper, lawful, and reputable manner”, and to “comply in all matters with all laws, ordinances, rules, regulations, orders, and public authorities or officers exercising any power of regulation or supervision over tenant or the premises, or the use or operation thereof.” Tenant timely opened its restaurant and operated its restaurant in compliance with the lease.

Fast forward to March 2020.  On March 9, 2020, JB Pritzker, Governor of Illinois, declared all counties in the State of Illinois as a disaster area in response to the outbreak of COVID-19. On March 11, 2020, the World Health Organization characterized the COVID-19 outbreak as a pandemic. On March 13, 2020, President Trump declared a nationwide emergency pursuant to Section 501(b) of the Robert T. Stafford Disaster Relief and Emergency Assistance Act, 42 U.S.C. 5127-5207 (the “Stafford Act”) covering all states and territories, including Illinois. On March 18, 2020 the Commissioner of Health of the City of Chicago issued a Shelter in Place For COVID-19 Order. On March 20, 2020, the Governor of Illinois issued Executive Order 2020-10 directing Illinois residents to stay at home.  On March 26. 2020 the Commissioner of Health of the City of Chicago issued Order No. 2020-3 applying the Governor’s Stay-At-Home Order closing numerous public areas, restricting public and private gatherings, and restricting travel. On March 26, 2020, President Trump declared a major disaster in Illinois pursuant to Section 401 of the Stafford Act.  In the midst of the onset of the COVID-19 disaster, the tenant, Roti, “closed the premises” on Mach 18, 2020 and stopped paying rent.

In August 2020, the landlord filed suit for eviction and rent, alleging that Roti entered into a lease to rent the premises but failed to pay rent under the lease since March 2020. The landlord sought possession and $79,173.88 in past due rent as of the date of filing the complaint.

Roti defended the lawsuit by admitting it was a party the lease but arguing that it was essentially dispossessed on the premises in March 2020 and excused from performance of the lease because it was complying with public health orders. It also claimed that it was excused from performance because of civil unrest resulting in looting and rioting that began on May 28, 2020. Roti asserted that both the public health orders and the unrest “made it illegal and impossible or impractical for Roti to operate a restaurant at the premises as anticipated under the lease, its sole permitted use of the Premises.”

Roti raised five affirmative defenses. An affirmative defense claiming COVID-19 constituted a physical casualty was rejected based upon the language of the lease. The other four affirmative defenses, as well as two counterclaims, were based upon the common law doctrines of impossibility or impracticability of performance, and commercial frustration of purpose. There was no applicable force majeure provision in the lease, resulting in only common law defenses being available.   

Eventually, both the landlord and the tenant filed cross motions for summary judgement, which were heard on January 8, 2021.

Tenant Roti’s motion for summary judgment was based primarily upon the common law doctrines of impossibility and frustration of purpose. It was supported by a sworn declaration alleging facts in support of its defense that the public orders relating to COVID-19 made it impossible or impractical to conduct business as a restaurant from the premises.

Landlord’s motion for summary judgement argued that Roti had not established impossibility or frustration of purpose, and that Roti was in default, without legal excuse, for failure to pay rent as required by the lease.  In support of Landlord’s motion for summary judgment the Landlord filed a sworn declaration alleging that other restaurants or cafes in the vicinity of the premises remained open and operating during the COVID-19 pandemic and, in fact, a Potbelly and a Starbucks in the same building a the premises “are currently open for business and have been open during much of the pandemic.”  Roti responded that Landlord’s sworn declaration did not specifically refute Roti’s declaration that the public orders made it impossible and impractical to operate its business and noted that other businesses “have different physical setups, business models, and management decision-making”.

The trial court granted Roti’s motion for summary judgment and denied Landlord motion for summary judgement based upon the doctrines of impossibility and frustration of purpose, noting that restaurants cannot make enough money to pay their staff during governmental restrictions for COVID-19 and opined that restaurants would not be profitable until they could return to full operational capacity.   The trial court ruled that “the lease remains in full force and effect except that all rent payments by Roti are abated until the public health orders are lifted such that Roti can return to full operational capacity.” The Landlord appealed.  

Addressing the doctrines of impossibility, impracticability, and frustration of purpose, the Appellate Court spelled out the conditions for application of each doctrine, noting that in each case the doctrines of impossibility, impracticability and commercial frustration are to be narrowly construed.

The doctrine of impossibility, the Appellate Court noted, excuses performance only if the performance is rendered objectively impossible because the subject matter of the contract is destroyed or by operation of law. The doctrine applies only if the parties did not and could not anticipate the circumstances creating the impossibility, the party claiming impossibility did not contribute to the circumstance, and that party demonstrates it tried all practical alternatives to allow performance. The person claiming impossibility has the burden to prove it.

The doctrine of impracticability applies only where, “after a contract is made, a party’s performance is made impractical without its fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made. . .” As with the doctrine of impossibility, a party claiming impracticability is expected to make a reasonable effort to overcome obstacles to performance and will be excused only if performance is impractical despite reasonable efforts. A party seeking to excuse performance by reason of impracticability must show that it can operate only at a loss and that the loss will be so severe and unreasonable that failure to excuse performance would result in a grave injustice.

The doctrine of commercial frustration rests on the proposition that, “from the nature of the contract and surrounding circumstances” at the time the parties entered into the contract, the parties “must have known that it could not be performed unless some particular condition or circumstance would continue to exist.” The parties must be deemed to have entered into the contract on the basis that “the condition or circumstance would continue to exist, so that the contract is construed to be subject to an implied condition that the parties shall be excused from performance if performance becomes impossible from such condition or circumstance ceasing to exist.

Applying the doctrines of impossibility, impracticability, and commercial frustration to COVID-19, the Appellate Court found “no genuine dispute that the parties did not and could not anticipate the circumstance allegedly causing impossibility – the COVID-19 pandemic and the public health orders – when they entered into the lease, nor that Roti did not contribute to the circumstances of the pandemic or the said orders”. Similarly, the Appellate Court found “no genuine dispute that the allegedly frustrating event – again, COVID-19 and the orders – were not foreseeable when the lease was formed.”

The Appellate Court noted that summary judgment is a drastic means of disposing of litigation and should be granted only where there is no genuine issue of a material fact. In reversing the trial court, the Appellate Court found that a genuine issue of material fact prevented entry of summary judgment for either party. Roti claimed that operating a restaurant from the premises during the pandemic was impossible. Landlord claimed other restaurants in the vicinity, including restaurants in the same building as the premises, were open during the pandemic. The factual issue was whether Roti’s efforts established that Roti had tried all available practical alternatives to perform under the lease and that operating a restaurant during the pandemic was objectively impossible. To be excused, performance must be objectively impossible.  To be objectively impossible, the facts must show that “the thing cannot be done”.  If the facts show only that “I cannot do it”, the facts establish only subjective impossibility, which is not sufficient to excuse performance.

Accordingly, the Appellate Court reversed and remanded for further proceedings on Landlord’s complaint and Roti’s affirmative defenses and counterclaim.

*This article by R. Kymn Harp first appeared in the April 2022 Newsletter of the Illinois State Bar Association’s Section on Real Estate Law, Vol. 67, No. 9.

Adaptive Reuse Of Underutilized Real Estate

Cool Projects – A Love Affair Revisited

We are entering a new frontier for adaptive re-use. The worldwide COVID-19 pandemic has left the urban commercial landscape in tatters. Shuttered vacant commercial space is commonplace throughout cities and towns. Doors and windows are boarded-up in shopping districts and entertainment districts that were thriving as recently as February 2020. Some have become barely recognizable.

Looking to the Future

What is to become of this vast inventory of vacant retail space, shuttered restaurants, empty hotels and office buildings, abandoned shopping malls, cavernous and empty theaters, stranded travel destinations, and more? Who will have the vision and courage to adapt and redevelop these properties into newly viable economic jewels? And when?

Make no mistake; it will happen. And it’s likely to happen much more quickly than you think.

While many are just beginning to peak their cautious heads out from under their COVID blankets, value-add developers are assembling to scoop-up valuable assets to be reimagined and repositioned for economic glory. If you believe the residential real estate market is hot, hold onto your collective hats. There are enormous profits to be made in commercial real estate and new business. These COVID-depressed sectors have struggled during the COVID shutdown, but unless the government blows it with short-sighted regulation and foolish tax policy, substantial economic revitalization is about to commence. Jobs, business opportunities, community-desired services and amenities, and great economic rewards are on the horizon. The ingenuity and creativity of value-add developers and the entrepreneurs they enable, coupled with vast amounts of available capital, are about to be unleashed in a torrent.

Pent-up demand is a powerful force. We are about to witness the creative power of visionary value-add developers as they reimagine and reinvent vacant and underutilized commercial space and turn it into some remarkably Cool Projects. I can’t wait!

COOL PROJECTS – Real Estate Projects I Love to Work On.

I love cool real estate projects. Cool projects are why I became a lawyer. Cool projects are why I come to the office each day. Cool real estate projects are why I did not become an astrophysicist (well, one reason – although, that might have been cool too). Cool projects are the reason I live, smile, dance, breath, scour the earth for new deals, jump for joy.

And by “cool”, I don’t mean in a thermal sense – but rather in a “this project is so cool” sense. I am referring to real estate projects that are awesome. Real estate projects that are fun. Real estate projects that make you say “Wow – what a cool project!”

Cool projects don’t need to be costly projects in major urban centers – although those can be cool too. I’m talking about projects that are creative. Projects that require vision and imagination. Projects that take something mundane and turn it into something special.

Some people think I only like huge projects. To be honest, I do like huge projects, but largely because the huge projects I have worked on also happened to be cool projects.

Redevelopment of the commercial portions of Marina City in downtown Chicago was a cool project. Ground-up development of Sears Centre Arena in Hoffman Estates, Illinois was a cool project. Work on various mixed-use projects around the Midwest and upstate New York have been cool projects. But so has been the much smaller development of an 8,000 square foot microbrewery in the historic Motor Row District of Chicago using TIF financing; development of countless restaurant and entertainment venues throughout the Midwest; conversion of a multi-story industrial building into a high-tech office center; conversion of an outdated office building into a stylish, luxury hotel; adaptive reuse of outdated retail strip centers, bank buildings, city and suburban office buildings, bowling alleys, warehouses, industrial buildings, gas stations, and various small to medium sized special purpose buildings into modern, fully functional jewels – reinvented to provide much needed retail and service amenities for local neighborhoods and communities. It is not the size of the project that makes it cool – or the cost – it is the concept, imagination and creative challenge involved that makes the difference. At least for me.

Cool Projects Test

Here’s a test [call it the “Cool Projects Test”, if you will]:

Which of the following projects is more likely to end up on Kymn Harp’s list of cool projects?

PREDICTION:  Tax rates will rise, and property values will increase.

IRC Section 1031 allows sellers of qualifying real estate to exchange it for like-kind real estate and defer payment of taxes. . . possibly forever.

WHAT IS A TAX-DEFERRED EXCHANGE?

Section 1031 of the Internal Revenue Code allows any real estate in the USA held for investment or for use in the taxpayer’s trade or business to be exchanged for other like-kind property without payment of federal income taxes. Most states tax codes provide likewise. There are technical rules for completing the exchange, but it is a straightforward process with clear-cut rules expressly authorized by law.

Taxes that can be deferred include all capital gains taxes, all depreciation recapture taxes, all passive-investment taxes (so called “Obamacare taxes”), and, in most cases, state income taxes. In many circumstances, these taxes can add up to in excess of 30%. Instead of paying taxes, why not reinvest those funds as equity in another like-kind property instead, and continue to receive an investment return on those funds?

HOW IS LIKE-KIND PROPERTY DEFINED?

• A concept that is often misunderstood is “like-kind” property. The definition is much broader and simpler that some might expect. Basically, any real estate located in the USA and held for investment or for use in the taxpayer’s trade or business can be exchanged for any other USA real estate held for investment or for use in the taxpayer’s trade or business without paying taxes. That means, for example:

The physical use of the real estate is not what makes it like-kind; rather, all real estate located in the USA is like-kind to all other real estate located in the USA. Likewise, foreign real estate is like-kind to other foreign real estate, but it is not like-kind to USA real estate. The condition is that (i) the real estate being sold must have been held for investment or for use in the taxpayer’s trade or business, and not held primarily for resale, and (ii) the real estate being acquired must likewise be acquired for investment purposes or for use in the taxpayer’s trade or business and not primarily for resale.

ARE THERE TIME CONSTRAINTS?

At the time of closing, the taxpayer does not need to know exactly what property will replace the property being sold. The taxpayer has 45 days to identify potential replacement property, and up to 180 days after closing to acquire the replacement property. A key, however, is that the selling taxpayer cannot come into physical or constructive possession of the sale proceeds during the exchange period. To satisfy this condition, the seller will designate a qualified intermediary to hold the funds under an exchange trust agreement. This can be done quickly, often within a day or two before closing if necessary. Although the seller/taxpayer does not have the right to access the funds during the exchange period, the seller/taxpayer does have the right to direct the qualified intermediary to apply the funds toward the taxpayer’s purchase of any replacement property which is identified by the taxpayer during the 45-day identification period.

For all taxes to be deferred, the entire sale proceeds of the real estate being sold must be used to acquire the replacement property. For this purpose, “sale proceeds” includes all cash received at closing and any mortgage indebtedness that was paid off.

INCIDENTAL PERSONAL PROPERTY

Prior to January 1, 2018 tax-deferred exchanges of certain personal property were also permitted. The 2017 Tax Cuts and Jobs Act, effective January 1, 2018, ended this practice and limited tax-deferred like-kind exchanges to only real property. This raised concerns as to whether certain personal property commonly incidental to a sale of commercial property, such as appliances, carpeting, HVAC systems, security systems, Wi-Fi systems, trade fixtures, etc. would disqualify an exchange for tax deferral, or constitute taxable “boot”.

Under Final Regulations published by the Treasury Department effective December 2, 2020, personal property that is incidental to real property acquired in an exchange will be disregarded and may therefore be included as part of the tax-deferred exchange. Personal property is considered “incidental” in commercial transactions if (a) it is the type of personal property typically transferred together with real property, and (b) the aggregate fair market value of the personal property transferred with the real property does not exceed 15% of the aggregate fair market value of the replacement real property received in exchange.   

ADVANTAGES AND DISADVANTAGES

There are many advantages and not many disadvantages to structuring a sale as a tax-deferred exchange. The rules are technical but not very difficult to apply. It has virtually no impact on the buyer and provides extraordinary benefits to the seller.

For a real estate lawyer, besides providing a great service to your clients, an exchange provides a direct lead-in to the next transaction with an opportunity to handle the purchase of replacement property of equal or greater value that must close within 180 days.

Our tax code provides this benefit; it is up to real estate professionals to take advantage.

Thanks for listening . . .

Kymn

If experience teaches us anything, it teaches that the COVID-19 pandemic will end.  Things we enjoyed before, will be enjoyed again. People still want to shop, travel, dine-out, go to theater, attend live concerts and sporting events, marvel at fireworks displays, celebrate family gatherings, and do all the things that enrich our lives.  Demand did not simply evaporate; it remains strong. Pressure is building. Pent-up demand is rising. It is waiting to be unleashed. Are you ready?

Pundits speak of a “new normal” – but what does that even mean?

Not long ago, during the Great Recession, we heard talk of a new normal as well. How long did it take for that new normal to become a faded memory once the economy rebounded and began to expand? (Not long.)

Clearly, this pandemic has been devastating, with tragic loss of life, severe illness, and widespread economic devastation. New words and phrases have entered our lexicon, like asymptomatic, social distancing, bending-the-curve, intubation, N95, no-mask/no entry, quarantine, self-isolation, COVID-Lease amendments, COVID-abatements, PPP loans, sneeze-barriers, and the like. Although we learned in pre-school to “wash our hands”, we’ve gained new appreciation for this simple task since March 2020.

Discussions now focus on a need to reconfigure health facilities, office space, restaurants, hotels, conference centers, congregate living facilities, schools, places of worship, public transportation, shopping centers, and more, to prevent the spread of infectious disease.  Some claim this pandemic will cause a seismic shift away from urban living and centralized business districts, in favor of far-flung regions linked together by Zoom or other remote video-conferencing technologies.

But will it?  

A growing number of medical experts believe that multiple effective vaccines and treatments will be available shortly, which could bring the COVID pandemic to an end by the third or fourth quarter of 2021. What then?

When COVID cases are no longer in the news, will we remain preoccupied with social distancing, isolation, remote offices, and remote meetings? Or will be get back to business as usual?  Will we stay hunkered down in our suburban home-offices while our competition is out actively meeting with prospects and clients, looking for development opportunities, and doing business in person?

Is the central business district dead? Is urban living to be no more? Will theaters, bars, and restaurants remain closed? Navy Pier? Magnificent Mile? The restaurant and shopping scene in Chicago’s West Loop, Fulton Market, Pilsen, Greektown, Streeterville, Chinatown, Little Italy, Bronzeville, River North, and neighborhoods and suburbs beyond?  Are they gone for good? 

How long will it take before the “new normal” gives way to the “old normal” – with restaurants and banquet halls reopening, people dining out, going to live concerts, returning to the office, taking vacations, meeting in-person with customers, clients and friends, going to sporting events and live theater or the movies, spending money on leisure activities, buying urban condos, staying at downtown hotels, and doing all the things they recently enjoyed? 

What are the implications for adaptive reuse of commercial space left vacant by this pandemic, and for commercial real estate investment and development, and for business in general? What will be in demand this next summer and fall? 

What will be the turning point? Many of my clients are already looking past the pandemic to the next wave of opportunity. Are you?  

How are you positioning yourself for the opportunities that are coming? Is your professional team still intact? Did they retire? Move away? Go out of business?

What opportunity awaits?

            Are you ready for what comes next? Should we talk?

Thanks for listening,

Kymn

In 1002 E. 87^th Street LLC v. Midway Broadcasting Corp., 2018 IL App (1st) 171691, the plaintiff (“87^th Street”) filed suit to evict the defendant, Midway Broadcasting Corporation (“Midway”) for unpaid rent. 87^th Street also sought to collect on a guaranty of the lease. The trial court dismissed, finding that 87^th Street lacked standing to recover rent that accrued before it owned the property. The trial court also granted the tenant, Midway, attorneys’ fees in defending the action, as the prevailing party. The appellate court affirmed.

Under the facts of the case there was no question Midway was behind on its rent owed to the prior owner of the leased premises before the premises were conveyed to 87^th Street by deed. The premises were sold however, and the new owner (87^th Street) claimed Midway was in default by reason of past due rent owed to the prior owner.

  87^th Street claimed that as a successor standing in the shoes of the landlord to which the tenant had a duty to attorn it had standing to sue under the provisions of the lease which provided that “[n]o failure of landlord to exercise any power . . . or to insist upon strict compliance . . . and no custom or practice of the parties . . . shall constitute a waiver of Landlord’s right to demand exact compliance with the terms . . . .”

  The lease provided that Midway would pay rent “without abatement, demand, deduction or offset whatsoever . . .” and also provided that the landlord “shall include the party named as such in the first paragraph hereof, its representatives, assigns and successors in title to the Premises.” The lease further provided that when an original owner conveys the property, the “tenant agrees to attorn to such new owner.” Additionally, this provision of the lease provided that when the original landlord conveys the property, all liabilities and obligations of the original landlord “shall be binding upon the new owner.” The lease further provided that the prevailing party in enforcing the lease “shall be entitled to recover from the nonprevailing party any costs, expenses and reasonable attorneys’ fees incurred.”

The appellate court in 1002 E. 87^th Street LLC held as follows:

In general, a landlord has standing to sue for unpaid rent. 735 ILCS 5/9-209 (West 2014), American Management Consultants, LLC v. Carter, 392 Ill. App. 3d 39, 44 (2009). If a landlord conveys property by warranty deed without reserving any rights, he or she also conveys the leases for the property, as well as the right to receive unaccrued rent. Pros Corporate Management Services, Inc. v. Ashley S. Rose, Ltd., 228 Ill. App. 3d 573, 580 (1992). If a tenant fails to pay rent that becomes due, the new landlord has standing to sue for it. Id. at 580-81; American Management Consultant, LLC, 392 Ill. App. 3d at 44; Dasenbrock v. Interstate Restaurant Corp., 7 Ill. App. 3d 295, 298 (1972). But the new landlord does not have a right to recover rent due from before it owned the property. Lipsultz v. Robertson, 407 Ill. 470, 474 (1950) (conveyed lease gives right to receive unaccrued rents). The original landlord retains any right to recover past due rent. Dasenbrock, 7 Ill. App. 3d at 302.

1002 E. 87^th Street, 2018 IL App (1st) 171691, ¶ 17.

The court went on to note: “Unlike credit card debt and future rent that can be assigned, Illinois courts routinely hold that rent in arrears is not assignable.” [Internal citations omitted] 1002 E. 87^th Street LLC, Id. at ¶ 24

Additionally, the 1002 E. 87^th Street court held that because 87^th Street must be able to prove a breach of contract claim to collect on the guaranty, and 87^th Street cannot prevail on its breach of lease claim for past due rent owned to the prior owner, 87^th Street could not bring an action to collect on the lease guaranty. Id. ¶ 27

Finally, because the tenant, Midway, prevailed on its defense of the claims by the successor landlord seeking to evict Midway and to collect past due rent under the lease and under the guaranty, Midway was entitled to recover from 87^th Street, Midway’s costs, expense and reasonable attorneys’ fees incurred in defense of the successor landlord’s action.  

This outcome is not what most people (including many attorneys I know) expect. It can catch owners of newly acquired rental property off-guard, and can result in expensive unexpected consequences.

Thanks for listening,

Kymn

Opportunity Zones are among the hottest of Hot Topics in real estate investment today.  With the December 22, 2017 enactment of the Tax Cuts and Jobs Act that added Section 1400Z to the Internal Revenue Code, Opportunity Zones were authorized as a potentially powerful tax deferral and tax exclusion incentive to develop predominantly low-income communities. The tax issues related to Opportunity Zone investment are multilayered and complex, but the essential tax benefits are reasonably straightforward and easy to understand. The potential tax benefits of investment in Opportunity Zones are serving as an exciting foundation for investment in community redevelopment. Opportunity Zones are not, however, the tax and investment panacea some imagine.

STATUTORY AUTHORIZATION

Authorization to create Qualified Opportunity Zones was set forth in new IRC Section 1400Z-1. Special rules for treatment of capital gains invested in Qualified Opportunity Zones are set forth in Section 1400Z-2.

DESIGNATION OF OPPORTUNITY ZONES

As of December 2018, all Qualified Opportunity Zones have been designated. Each Opportunity Zone corresponds to a Census Tract meeting certain low-income guidelines. There is currently no mechanism to create any additional Qualified Opportunity Zones or to expand or modify any existing Qualified Opportunity Zone.  Various mapping tools are available online to enable you to locate Qualified Opportunity Zones and to determine whether any specific property is located within a Qualified Opportunity Zone and therefore eligible for the special tax treatment authorized by IRC 1400Z-2. 

THREE KEY TAX BENEFITS OF OPPORTUNITY ZONE INVESTMENT

The three principal tax benefits of investment in a Qualified Opportunity Zone, assuming the technical rules required by IRC 1400Z-2 and the implementing regulations are satisfied, are as follows:

1. Tax Deferral. Tax on capital gain reinvested in a Qualified Opportunity Zone is deferred until December 31, 2026 (unless the investment is sold or exchanged prior to that time).  See: IRC §1400Z-2 (B). The capital gain subject to deferral is not limited to just capital gains from the sale of real estate, but also includes other capital gains, including those derived from the sale of stock and partnership interests as well.
2. Partial Exclusion of Deferred Gain; 5 Year and 7 Year Holding Periods. A portion of the deferred gain reinvested in a Qualified Opportunity Zone for five years or seven years is excluded from taxation by increasing the tax basis of the investment by a percentage of the reinvested gain. In the case of an investment held for at least five (5) years, the tax basis of the investment is increased by an amount equal to ten percent (10%) of the amount of the deferred gain. In the case of an investment held for at least seven (7) years, the tax basis of the investment is increased by an amount equal to an additional five percent (5%) of the amount of the deferred gain, with the result that after seven (7) years of gain deferral the basis of the property will have increased by an aggregate of fifteen percent (15%) of the deferred gain. Since the recognition date for deferred gain is December 31, 2026 pursuant to IRC §1400Z-2(B), as referred to above, in order to receive the maximum tax benefit the gain must be reinvested in a Qualified Opportunity Zone on or before December 31, 2019 (seven years before December 31, 2026). But still, the tax benefits for the five (5) year holding period remains available for investments made through December 31, 2021. See: IRC §1400Z-2(B).
3. Stepped-Up Basis For Post-Investment Gain; 10 Year Holding Period. Perhaps the most powerful incentive is the special rule for investments held for at least ten (10) years. Pursuant to IRC §1400Z-2(C), in the case of a qualifying investment in a Qualified Opportunity Zone held by the taxpayer for at least 10 years, upon election by the taxpayer the basis of the investment will be stepped-up to its fair market value as of the date the investment is sold or exchanged. The effect of this provision is to exclude all appreciation in the investment from taxation (although it should be noted that the taxpayer would have been obligated to recognize and pay tax on 85% of the initially deferred gain (7-year holding period) or 90% of the initially deferred gain (5-year holding period) as of December 31, 2026).  If there has been substantial appreciation during the holding period of ten or more years, no tax on that gain will be owed if the taxpayer elects to have the tax basis stepped-up to the fair market value of the investment as of the date it is sold or exchanged. See:  IRC §1400Z-2(C).

EXAMPLE:   Suppose QOZ investor sells an asset and realizes a capital gain of $500,000 on October 1, 2019, and then decides to invest that $500,000 in gain in a Qualified Opportunity Zone investment on or before November 1, 2019.   The tax on that gain is deferred until December 31, 2026 or until the investment is sold, whichever first occurs.  If the investment is held at least five years, as of November 1, 2024, the basis in the investment will be increased by 10%, meaning $50,000 of the originally invested $500,000 gain is excluded from taxation. If the investment is held at least another two years (for a total of seven years), as of November 1, 2026 the basis in the investment will be increased by another 5%, meaning an additional $25,000 of the originally invested $500,000 is excluded from taxation.  As of December 31, 2026, the remaining deferred gain of $425,000 ($500,000 minus $50,000 (the 5-year exclusion) and minus $25,000 (the 7-year exclusion) will be realized, with the result that taxes shall be due on $425,000 of the originally deferred gain as of the investor’s tax filing date in 2027.  

Suppose also that in the ten or more years following the initial investment of gain on October 1, 2019 the Qualified Opportunity Zone property in which the investment was made appreciated substantially, with the result that the post-investment gain attributable to the initial $500,000 investment (i.e. the gain after October 1, 2019) is $2,000,000.  Under IRC §1400Z-2(C), at the election of the taxpayer to step-up the basis of the property to fair market value, the $2,000,000 post-investment gain is excluded from taxation.

OPPORTUNITY ZONES AS SOCIAL-IMPACT LEGISLATION

The challenge for Opportunity Zone investing is that it is not enough to simply “invest” and hold in an Opportunity Zone. Instead, either (i) the original use of qualified opportunity zone business property must commence with the investment of qualified opportunity funds, or (ii) if the property is already in use, it must be substantially improved within thirty (30) months.  Generally speaking, “substantial improvement” means improving the property by an amount equal to the cost basis of the property upon acquisition by purchase after December 31, 2017, less any amounts reasonably allocated to land. See: IRC §1400Z-2(d)(2)(D).

Opportunity Zones were designed to inspire social-impact projects. Investment projects in Opportunity Zones are supposed to make a positive difference for the low-income community in which it is situated. The investor seeking the tax advantages of investing in a Qualified Opportunity Zone must put its funds to work to create economic opportunity in the community. Merely investing in an existing property or business is not enough.

SECTION 1031 TAX BENEFIT vs. OPPORTUNITY ZONE TAX BENEFIT

A question I am often asked is whether an Opportunity Zone Investment is better than a tax-deferred exchange pursuant to IRC Section 1031? The short answer is that one is not inherently better than the other, they are just different. It’s like asking whether penicillin is better than a sandwich. Clearly, if you are merely starving a sandwich is better. If you have a bacterial infection, you might be better off using penicillin.  The tax benefits of investing in a Qualified Opportunity Zone are different from the tax benefits offered by a tax deferred exchange of like-kind property pursuant to IRC Section 1031, and the circumstances under which each may be beneficial are different. Each has its place. I will be posting an updated article on IRC Section 1031 tax-deferred exchanges shortly.

OPPORTUNITY ZONES AS ECONOMIC DEVELOPMENT INCENTIVE

Qualified Opportunity Zone investments in real property require significant capital improvements and the acceptance of a substantial degree of investment risk. The investment risk is that the property must yield acceptable investor returns to sustain the project over a holding period of at least 5 years, but ideally 10 years, and that during the 10-year holding period the property will substantially appreciate in value, making the promised exclusion of gain taxation meaningful.  Because of the substantial investment required to substantially improve property (i.e. double the basis of the existing improvements) and the uncertainty that the primary tax benefit to be derived from appreciation in value over 10 or more years will be achieved, today’s value of property is not automatically enhanced merely because it is located within an Opportunity Zone as some existing owners seem to believe. The project itself must make substantial economic sense on its own – just as if it were not in an Opportunity Zone. The tax benefits available through a Qualified Opportunity Zone investment will not make a poor investment or a marginal investment good. They will only make a good investment better. 

What makes a Qualified Opportunity Zone investment similar to a IRC Section 1031 Exchange is that they both provide for tax deferral. Tax deferral for a Section 1031 investment is potentially without end. Tax deferral for a Qualified Opportunity Zone investment is temporary, but carries with it the additional benefit of potential exclusion of gain from taxation.  Section 1031 exchanges have been part of the Internal Revenue Code for nearly 100 years and are well understood as a tax deferral tool. Qualified Opportunity Zone investments are a brand-new tax mitigation tool authorized in December 2017, with the rules for their use still being written.

The potentially powerful tax incentives offered by Qualified Opportunity Zone investment, coupled with their focus on revitalizing economically distressed communities, is what has made investing in Opportunity Zones one of the hottest topics in real estate.

END*

*NOTE: The foregoing article is for educational purposes and is not intended as tax advice. Taxation of Opportunity Zone investments is highly technical and fact sensitive. Consult with your own tax advisor when applying the subject matter of this article to any specific tax scenario.

If commercial real estate is being sold and the seller is planning to buy again, the seller should seriously consider a tax-deferred exchange. So long as the closing has not yet occurred, it is not too late. Why pay taxes on sale proceeds when it’s not necessary? Invest those funds as equity instead.

WHAT IS A TAX-DEFERRED EXCHANGE?

Section 1031 of the Internal Revenue Code allows any real estate in the USA held for investment or for use in the taxpayer’s trade or business to be exchanged for other like-kind property without payment of federal income taxes. Most states tax codes provide likewise. There are technical rules for completing the exchange, but it is a straightforward process with clear-cut rules expressly authorized by law.

Taxes that can be deferred include all capital gains taxes, all depreciation recapture taxes, all passive-investment taxes (so called “Obamacare taxes”), and, in most cases, state income taxes. In many circumstances, these taxes can add up to in excess of 30%. Why not reinvest those funds in another like-kind property instead, and continue to receive an investment return on those funds?

HOW IS LIKE-KIND PROPERTY DEFINED?

A concept that is often misunderstood is “like-kind” property. The definition is much broader and simpler that some might expect. Basically, any real estate located in the USA and held for investment or for use in the taxpayer’s trade or business can be exchanged for any other USA real estate held for investment or for use in the taxpayer’s trade or business without paying taxes. That means, for example, an apartment building could be exchanged for a warehouse, retail store, or farm, and vice versa. Vacant land held for investment could be exchanged for a shopping center. An apartment building could be exchanged for an office building. The physical use of the real estate is not what makes it like-kind; rather, all real estate located in the USA is like-kind to all other real estate located in the USA. Likewise, foreign real estate is like-kind to other foreign real estate, but it is not like-kind to USA real estate. The condition is that the real estate being sold must have been held for investment or for use in the taxpayer’s trade or business, and the real estate being acquired must likewise be acquired for investment purposes or for use in the taxpayer’s trade or business.

ARE THERE TIME CONSTRAINTS?  

At the time of closing, the taxpayer does not need to know exactly what property will replace the property being sold. The taxpayer has 45 days to identify potential replacement property, and up to 180 days after closing to acquire the replacement property. A key, however, is that the selling taxpayer cannot come into physical or constructive possession of the sale proceeds during the exchange period. To satisfy this condition, the seller will designate a qualified intermediary to hold the funds under an exchange trust agreement. This can be done quickly, often within a day or two before closing if necessary. Although the seller/taxpayer does not have the right to access the funds during the exchange period, the seller/taxpayer does have the right to direct the qualified intermediary to apply the funds toward the taxpayer’s purchase of any replacement property which is identified by the taxpayer during the 45-day identification period.

For all taxes to be deferred, the entire sale proceeds of the real estate being sold must be used to acquire the replacement property. For this purpose, “sale proceeds” includes all cash received at closing and any mortgage indebtedness that was paid off.

ADVANTAGES AND DISADVANTAGES

There are many advantages and not many disadvantages to structuring a sale as a tax-deferred exchange. The rules are technical but not very difficult to apply. It has virtually no impact on the buyer and provides extraordinary benefits to the seller.  

For a broker, an exchange provides a direct lead-in to the next transaction, with an opportunity to broker the purchase of replacement property of equal or greater value that must close within 180 days.

Our tax code provides this benefit; it is up to real estate professionals to take advantage.

Two Things You Need to Know

As my readers know, I often represent real estate investors. When I draft a real estate contract I strive to make each provision absolutely clear in its meaning, and try to have it serve as a workable road map to closing.  Occasionally a client will draft a real estate contract on its own (or have a broker draft it), and sign it without my review or input. The client will then send it to me “to close the transaction“.  Though I counsel clients that this can be a remarkably risky practice, some clients . . . being clients . . .  do as they wish and ignore my advice. Such is life.

When faced with closing a transaction governed by a real estate contract I did not have a hand in preparing, I do my best.  It is usually not a complete disaster, but there are often misunderstandings because of provisions that are not entirely clear.

There are also situations where a provision in a real estate contract may be legally sufficient, but the seller and/or its attorney simply don’t understand the actual meaning of the provision.  With a clearer provision the misunderstanding could be avoided, but the legal ramifications of certain provisions still are what they are, rather that what some imagine them to be. The following are two examples I have run into in the last week that I believe deserve comment and explanation:

NO MORTGAGE CONTINGENCY:     Contrary to the understanding by some Seller’s attorneys and their clients, the fact that a real estate contract does not include a mortgage contingency – and may even expressly state that the transaction is not contingent upon the Buyer obtaining a mortgage – does not mean that the Buyer is not obtaining a loan and using mortgage financing.  It simply means that the Buyer’s obligation to proceed to closing under the real estate contract is not contingent upon the Buyer obtaining a mortgage loan.

Many investor Buyers have strong relationships with their lender. They know what their lender requires, and know that the property they are acquiring will qualify as collateral for a mortgage loan from their lender. Consequently, they do not make obtaining a mortgage a contingency to closing in the real estate contract. Be that as it may, the Buyer may still obtain a mortgage loan, and may fund the property purchase using loan proceeds.

This is the practical equivalent to the situation where a real estate contract does contain a mortgage contingency, but the contingency has been satisfied because the Buyer has been approved for a mortgage loan. At that point the contingency expires and the contract is no longer subject to a mortgage contingency. The Buyer will still be closing using its lender and the proceeds of its mortgage loan. Probably no one disputes that.

Likewise, in a real estate contract where there is no mortgage contingency from the beginning, the absence of a mortgage contingency does not, without more, imply at all that there will be no mortgage lender.  If the parties intend to provide that a contract is to be a cash transaction with no lender, that should be expressly provided in the real estate contract. Otherwise, the mere absence of a mortgage contingency does not mean there will be no lender – it simply means the Buyer is taking the legal and financial risk that a mortgage will be obtained.

2.   AN “AS IS” CLAUSE DOES NOT MEAN NO INSPECTION:  As with the absence of a mortgage contingency clause, as discussed in point 1 above, there seems to be some confusion about what an “AS IS” provision in a real estate contract means.

It has recently been suggested to me by Seller’s counsel that since the Buyer is purchasing property in “AS IS” condition that there is no need for the Buyer to have an inspection period with the right to inspect the condition of the property. To the contrary, where a Buyer has agreed to acquire property in AS IS condition, it is absolutely vital for the Buyer to have an opportunity to inspect the property, with the right to terminate the transaction if the condition of the property is materially worse than the Buyer expected. The AS IS provision in a real estate contract simply means that the Buyer does not expect the Seller to make any repairs to the property, or expect the Seller to provide closing credits for defective conditions in the property, and that the Buyer will not come back to the Buyer after closing seeking recourse for undisclosed defects.

Having a provision in an real estate contract providing for an inspection period during which the Buyer can thoroughly inspect the property and terminate the contract within that period if the property is physically deficient is not at all inconsistent with a provision that the Buyer is agreeing to acquire the property in AS IS condition.  The need to inspect is a matter of due diligence for the Buyer. If the Buyer inspects the property (or fails to inspect the property) and does not  exercise its right to terminate within the inspection period provided in the real estate contract, then the Buyer is bound to close regardless of the condition of the property – with the possible exception of additional damage occurring to the property after the contract date, or at least after expiration of the inspection period.

These are simple points, but they are misunderstood more frequently than one would hope or expect. To avoid needless misunderstandings, careful and meticulous drafting is a solution.  But still . . . this is not rocket science.

Thanks for listening. . .

Kymn