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The Rental Intercept, & Your Little Dog, Too

Aug 31, 2010 | Archive, Blog, Text Only Article | 0 comments

As Gayle Cagianut of Cagianut & Company astutely points out in her companion piece, “Lions and Tigers and Bears, Oh, My!! (The Association as Landlord)”, the road to Oz is not always full of pretty songs, sunny skies, and horses of a different color. For the first time in a generation we are seeing condominiums watch accounts and revenues shrinking more quickly than our clean water supply. Investor owners are walking away and throwing their keys at the bank. Owners, losing their jobs, stop paying their assessments. And everyone waits for the banks to foreclose. And waits and waits and waits . . .

Government policy and political rhetoric about moratoria on foreclosures compound the problem and delay the inevitable market correction. And the remaining owners – those with savings, equity, and retired folk on fixed incomes who have carefully saved through the years – end up holding the bag for the necessary expenses of maintaining and operating the condominium.

Condominium ownership is an involuntary partnership of strangers, and

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

William Butler Yeats, The Second Coming (1919)

There are limited solutions to restore order to our crazy world. You can’t compel banks to foreclose. Bill Gates and Warren Buffet won’t write you a check. Which means the association must choose between two undesirable choices: wait and do nothing to reduce the costs of collection, or commence an action to foreclose with the banks at its back. In either case, the association of remaining owners will probably be left holding the bag if and when the bank finally acts. The whole thing leaves one scratching one’s head and wondering if we only had brains.

The situation, awful, and profoundly dire for some associations, leads us to dig deeper into our grab bag of collection tools. One option, available in many governing documents, is to intercept rent from a tenant.

The right to intercept rent arises out of the association’s governing instruments or RCW 64.34.364 (for condominiums generally created after July 1, 1990):

(10) From the time of commencement of an action by the association to foreclose a lien for nonpayment of delinquent assessments against a unit that is not occupied by the owner thereof, the association shall be entitled to the appointment of a receiver to collect from the lessee thereof the rent for the unit as and when due. If the rental is not paid, the receiver may obtain possession of the unit, refurbish it for rental up to a reasonable standard for rental units in this type of condominium, rent the unit or permit its rental to others, and apply the rents first to the cost of the receivership and attorneys’ fees thereof, then to the cost of refurbishing the unit, then to applicable charges, then to costs, fees, and charges of the foreclosure action, and then to the payment of the delinquent assessments. Only a receiver may take possession and collect rents under this subsection, and a receiver shall not be appointed less than ninety days after the delinquency. The exercise by the association of the foregoing rights shall not affect the priority of preexisting liens on the unit.

An Association considering a rental intercept must consider tax consequences (see the companion piece), the cost of a receivership that may exceed monthly rent (where a receiver is required), risk management where the Association, acting as landlord, has no insurable interest in the rented unit, the potential claims against an association by a bank with a superior right to intercept rent, and human nature. An Association, exercising due diligence, might go through a cost-benefit analysis to determine the best course of action. The listed considerations are not intended to be exhaustive or mandatory.

Let’s discuss human nature. Renters believe they owe their allegiance first and foremost to the landlord-owner. When they receive an intercept demand from the association – an apparent stranger to their rental agreement – they likely will ignore the demand. If the Association elects to sue the renter for rent, most renters will flee rather than defend. And assuming the association actually obtains possession of a unit, what kind of renter is willing to rent on a month-to-month basis from an association without ownership or an apparent insurable interest?

There are legal considerations as well that weigh against the blind exercise of a rental intercept. In California, for example an association may put itself in the path of trouble if it pockets the rent without taking care of the mortgages encumbering the property: “’Rent skimming’ means using revenue received from the rental of a parcel of residential real property at any time during the first year period after acquiring that property without first applying the revenue or an equivalent amount to the payments due on all mortgages and deeds of trust encumbering that property.” Cal. Civ. Code § 890(a)(1). And “skimming” the rent from a unit exposes the skimmer to lawsuits from the owner, a senior lienholder, and the tenant. See, e.g., Cal. Civ. Code § 891. Unlawfully renting a unit without the owner’s consent is a crime. See Cal. Penal Code § 602.9. “As California goes, so goes the nation.” Prof. Edgar Dykstra. And so it goes.

In the final analysis, on a forward going basis, when something smells rotten in Denmark, and we’ve exhausted all the clichés, we really have to ask, is intercepting rent worth it? and is there no place like home?

Brian P. McLean is an attorney and shareholder at Leahy McLean Fjelstad in Kirkland, WA.

Lions, and Tigers and Bears, Oh, My!! (The Association as Landlord)

We’re off to see the Wizard ~

The trip down the yellow brick road was not always easy. Similarly, in today’s world Boards of Directors are navigating a treacherous path trying to keep the Association headed towards the Emerald City (that is, green for money). The current economy has Associations venturing down unmarked paths as they try and stay financially solvent. One direction taken by some Boards of Directors is to become a landlord by taking possession of a unit for the unpaid past due assessments. The Association then collects rents while awaiting the bank(s) to foreclose.

The Board needs to make sure that they understand the accounting and tax issues so as not to be caught unawares by any flying monkeys (aka the IRS and/or their auditor) along the way~

  • Rents are taxable income. Since the Association now “owns” the unit, the income is from a nonmember. This income should be segregated from other income on the financial statements.
  • Any expenses related to the rental can be deducted against the income on the tax return.  These should be clearly segregated from other expenses. The previously uncollected assessments (bad debts) cannot be a deduction against the rents.
  • Any costs associated with purchase of the unit or major repairs that need to be performed would be capitalized as “basis”. At the time of sale there were be a corresponding gain or loss on the sale of the asset.
  • For audit purposes, the sale must be fully disclosed. The Association should be prepared to provide all details and documentation to the year-end auditor.

There is no Wizard with all the right answers. In fact, when you pull back the curtain, you find that the Wizard is an ordinary person like any Board member. To make sure that “there is no place like home” the Board needs to enlist all the professional help they can before making important financial decisions. Be sure and consult with your manager, attorney, insurance provider and accountant before heading down this pathway.

By Gayle L. Cagianut, CPA

Cagianut & Company, CPA

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