Would You Live In Your Rental?

We ask the question in the title of this article because we want to make a point. Most tenants spend just as much effort into finding a new home as you put into marketing your vacancies, perhaps even more. Some may even put as much or more effort into the task as you would if you were looking for a new place to live.

All landlords want good tenants, where “good” basically means those who will pay the rent on time each month, take care of your property, and not cause trouble for your other tenants or residents of neighboring properties. The type of tenant you want should not be willing to live in just any property. If he is so undiscriminating that he doesn’t care about the quality of his housing, he probably won’t care about how he takes care of your rental or how he gets along with others.

Those looking for a new rental home evaluate available rentals in the same manner as you would evaluate a place to live. At the top of their list when beginning to look for rentals are location and price. They want a location in a safe and attractive neighborhood that is convenient to their workplace or school, to shopping, and to cultural and/or recreational attractions. Price is equally important to most tenants and, for many, has historically been of more importance than location. However, with $3-$4 per gallon gasoline (with possibility of even higher in the future), location is becoming evermore important, because long-distance driving can result in commuting expense comparable to rent. When a tenant does the math, he sees that he is ahead financially to pay an extra hundred dollars in monthly rent rather than commute an extra 20 miles per day round trip, 5 days per week.

Also of importance to most applicants is the condition of the rental property. Few tenants want to live in a unit where windows are cracked; the carpet is badly worn or dirty; the walls haven’t been painted since 6 tenants back; the toilet runs continuously (particularly if the tenant is paying the water bill); or any number of other possible deficiencies. While all units must meet habitability laws, you would almost certainly be unwilling to live in a unit that only just barely meets the law.

When a potentially good tenant sees a property that the landlord doesn’t maintain properly, he assumes that the landlord is likely deficient in other ways, for example, doesn’t respond to repair requests.

On the other hand, bad tenants see a poorly maintained property as a plus. They figure that a landlord who doesn’t take care of the front yard or maintain the wooden fence probably doesn’t run screening reports or check with previous landlords. Such a potential tenant may even assume that the landlord manages the property so loosely that he won’t even notice when the rent is a week or two late. If the potential tenant’s assumptions were wrong regarding screening, the landlord will have wasted time when the applicant fails to submit an application upon finding out about screening. If the applicant’s assumptions were wrong regarding rent collection, the landlord will likely have to deal with a problem tenant.

The next priority may be size and/or floor plan of the living space. The number of bedrooms and baths can be a critical issue. For some applicants, particularly the physically challenged, the rental unit being single-story is often very important even if handicap design features are not needed. When it comes to amenities, there can be a wide variety of items that are of varying degrees of importance. Some tenants must have a pool, while others absolutely won’t rent a property having a pool. Some tenants want laundry facilities within their unit, while others are happy with common laundry facilities on the property, and yet others don’t mind using a Laundromat as long as it is nearby.

Assuming that you already own the rental property, there is little that you can do about most of the issues discussed above. You can’t change the location or change the floor plan (at least cost-effectively). You could rent units for less than market value, but most landlords prefer to get market rents for their rentals.

The things that you can control are the condition of your property and how you represent yourself and your property. Attracting good tenants requires that the property be in good condition and that it show well. The latter means that it has curb appeal. While interior condition may eliminate applicants, you may not even get phone calls if the first impression of a potential tenant driving by prevents him from getting an appointment to see the inside or even calling for additional information.

Accordingly, landlords should maintain attractive landscaping, keep the exterior adequately painted, replace cracked windows, and properly maintain fencing, carports, and other exterior components. You don’t want to give the potential good tenants a reason for not renting your property before they even get inside.

Good flooring, attractive window coverings, clean and undamaged appliances and plumbing fixtures provide a good first impression when they view the interior. Amenities such as dishwashers, microwaves, and, in many climates, ceiling fans also help. Even the age of the heating/cooling system may be of interest in view of increasing energy costs. Offering living space that is both in good condition and attractive attracts better quality tenants, allows higher rents, and reduces the length of vacancies. The bottom line is that you will usually get a good return on your investment in providing housing that you might be willing to live in. Always ask the question, if you wouldn’t live there, why would a preferred applicant want to?

Risk Management – Part 1

Life is full of risks to health, safety, security, finances, and happiness. Investing in real estate adds a number of additional risks to one’s life. First, there is the risk of buying the wrong property, one that is in a bad location, in worse condition than you thought, and for which you paid way too much. Then, assuming that one purchases a good property at the right price, owning and managing that property has many categories of risks.

However, there are ways to reduce risk to acceptable levels. Reducing risk is basically a matter of having adequate knowledge and utilizing good risk management procedures.

With this article we begin a multi-part series regarding ways to manage the risks associated with rental property ownership.

Adequately managing risks of any business, including landlording, can be complex and time consuming, and can involve a number of components and potential complications. Good risk management is achieved through adequate organization and planning.

Risk management includes a variety of activities. Landlord-tenant relations, proper maintenance, adequate record keeping, formal safety programs, adequate insurance, and proper vesting of properties are some of the things that are part of a good risk management program. The goal of risk management is to anticipate and avoid future legal and other problems. When legal problems occur, the goal is to end them as efficiently as possible, which usually means obtaining an early settlement.

As for all businesses, landlords should have a risk management program in place. Some refer to such a program as asset protection. However, asset protection is actually only a part of risk management. Good risk management includes a number of issues in addition to asset protection. Asset protection becomes important primarily when all other risk management measures have not been totally effective. Considering that the goal of risk management is only to protect assets from creditors is a dangerously limited view.

Disaster planning is another part of risk management. Is your real estate investment business ready for a fire, a hurricane, a flood, or whatever other unexpected event might occur tomorrow, next week, next month, next year, and/or beyond? It is not only 9/11 or Katrina level disasters that should be of concern. Are you even prepared for a hard-drive failure that could occur at any time?

You may have already considered the most obvious risks, such as fire or injury related to your rental properties, and have bought insurance to protect against those risks. Unfortunately, there are hundreds of other liabilities with potential for loss that every landlord should consider, many of which are often overlooked or ignored.

Security deposits, lead-based paint, mold, and a bunch of fair housing items are only a few of the many potential land mines that landlords can encounter. Accordingly, it is important that, as a real estate investor, you (1) avoid being sued or becoming the subject of governmental investigation, (2) be the winner in any lawsuit or agency investigation that does occur, and (3) make sure that a potential judgment or penalty does not result in one landing in the poorhouse.

Exposure to lawsuits and governmental actions is minimized by having a good understanding of all the laws related to rental housing and following them all very carefully.

The odds of winning a lawsuit or being exonerated in a governmental investigation that does occur in spite of your best efforts are maximized by (1) not being having done anything seriously wrong in the first place and (2) having maintained adequate records to prove it.

Avoiding financial damage, even total ruin because of losing a serious lawsuit requires that one follow adequate asset protection procedures as part of a comprehensive risk management program. This includes utilizing proper vesting for all properties and carrying adequate insurance.

All risk management measures, including asset protection and disaster planning, require that you have to put things in place prior to occurrence of the catastrophe, not after the fact. Most attempts at after-the-fact maneuvering are usually ineffective. In fact, some methods of attempting to protect assets after the fact by transferring property are considered “fraudulent conveyance” and are illegal. You need to manage risks now, before the event occurs.

A few risks are predictable or at least are things that can be planned for and even controlled to some extent. Included in this category might be:

Death – “when” is sometimes somewhat controllable, “if” is never controllable

Taxes – second only to death in probability

Insurance premiums

Rents

Loan expenses

Employee costs

Operating expenses

Computer problems – backup, backup, backup

Other risks are unpredictable and usually beyond the landlord’s control. Included might be:

Illness, even permanent incapacity

Changing tastes in rentals

The local economy and its impact on the rental market

Actions taken by neighboring landlords

Actions taken by various levels of government or agencies thereof

Some events affect day-to-day operations only, others reduce profits, yet others result in hassle and stress, and still others can cause serious financial losses, even result in bankruptcy.

Risk management can be divided into the four approaches of:

Avoiding risks completely,

Controlling (minimizing) risks that can’t be completely avoided,

Transferring risks to other parties, and

Retaining risks of low probability and/or low maximum potential cost.

Some risks can be avoided or eliminated, others can be controlled or minimized, still others can be transferred to someone else, and some can and should be retained. However, before you can decide what to do about which, you need to identify and analyze them.

We will discuss each of the four approaches in future newsletters. A detailed discussion of risk management is provided in our “9 Steps to Managing Risks” Mini Training Guide.

Expenditures – Part 3 – Local Travel

In a recent newsletter (Expenditures – Part 2) we discussed some basic principles regarding expenditures including “travel expenses related to the property or management thereof.” In this newsletter we will discuss further a few aspects of this particular expenditure.

As stated in Expenditures – Part 1, to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

As also stated in Part 1, you can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. This will usually include educational costs related to managing your income properties. You must properly allocate your expenses between rental and non-rental activities. You cannot deduct the cost of traveling away from home if the primary purpose of the trip was related to the acquisition of a new property or the improvement of your existing property. These costs would be recovered by taking depreciation.

In this article, we will discuss only local transportation expenses in the normal course of managing rental property, leaving the significantly more complex issues related to other categories of travel (e.g., cruise ship seminars) for future discussions. Very few landlords utilize public transportation for travel related to management of properties reasonably close to their place of residence, so local transportation almost always means use of a private motor vehicle of some kind. This usually means a car, SUV, van, pickup truck, or panel truck. In most cases this vehicle is owned rather than being leased.

All landlords utilize one or more motor vehicles in managing their income properties. However, few landlords fully comply with the IRS requirements regarding the deductibility of vehicle use and many do not even come close.

You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Generally, if you use your personal vehicle for rental management activities, you can deduct the expenses using one of two methods: (1) actual expenses allocated to business use according to the percentage of miles driven for business compared to total miles driven for the year or (2) the standard mileage rate for the business miles.

Actual expenses can include essentially everything related to operation of the vehicle, including repairs and maintenance, insurance, and fuel. Depreciation or, with certain restrictions, Section 179 are also applicable to the business share of usage. For 2011, the standard mileage rate for a car, SUV, van, pickup, or panel truck is 51 cents a mile for all business miles. Changing from one method to the other is restricted by the IRS.

The IRS says that to take a business deduction for the use of your vehicle, you must determine whether the use was business or personal. If the answer is personal, no deduction is allowed.

Travel between home and an office where business is conducted is considered commuting and commuting miles are not deductible. However, for any business, travel is not considered commuting when your home is your principal place of business and the travel is to another work location in the same trade or business, regardless of whether that location is regular or temporary and regardless of distance. However, if you have an office where you perform a substantial part of the work related to the business, with this office being located other than at home, travel between home and that office will usually be considered non-deductible commuting even though you also maintain a home office.

To deduct vehicle expenses under either method, you must keep records that follow the rules in chapter 5 of IRS Publication 463. In order to determine the percentage of vehicle expenses or mileage that are business related and support the percentage in an audit, it is important that a log be kept. The log should include beginning and ending odometer mileage for each business related trip.

The IRS expects all business use of vehicles to be documented and your documentation may be required in an audit. Most tax experts interpret IRS requirements to be a written detailed log showing dates, times, purpose, and beginning and ending odometer readings for each trip driven. Whether or not such detail is really necessary, we mention the fact that one IRS publication states:

“….. to claim the deduction, keep adequate records, such as a written travel log with complete and accurate mileage records for each business use of your car. If you are unable to produce a clear and accurate business mileage record, the IRS may disallow the deduction.”

Does the language “such as” mean that there are other options? Whether a log is the only option or not, in order to be certain of the mileage deduction surviving an IRS audit, one who takes a deduction for business use of vehicles will be on firmer ground if able to produce a mileage log. While some may be able to reconstruct a log if needed from receipts and day-planner records, a contemporaneous log is best and is what the IRS means by a log. That is, writing down each trip including the date, time, destination, and the starting and ending mileage.

Although simply the miles for each leg or a round trip may be adequate in some cases, it is best to log starting and ending mileage. Although the trip meters available in most modern vehicles may seem a simpler way to keep track of a trip distance, recording only the trip meter results will not be nearly as convincing to an auditor as recording starting and ending mileages.

Logging in the day’s travels in the evening is doable if odometer mileage notes are kept throughout the day, but trying to recreate your travels at the end of each week (or longer) is next to impossible to do while remaining consistent with personal trips and fuel fill-up mileages so as to avoid discrepancies that might be discovered in an audit.

It is almost certain that the majority of self-employed individuals fail to keep a contemporaneous log with odometer readings for each stop, as the IRS would like to see, and it is likely that the percentage keeping any type of log at all is relatively low. Many simply roughly estimate their business mileage each year when doing their returns, some simply using a number that significantly reduces their taxable income.

Most know that only 1 to 2 percent of small business owners are audited and, even then, certain types of businesses are targeted whereas others are essentially ignored. For example, cash businesses are more likely to be audited than businesses where there is a bank record for most items of revenue. Furthermore, all audits won’t touch on the auto mileage issue anyway.

Therefore, in practice, the chance of being caught without a needed log is extremely low. For various reasons, all of the deduction taken is unlikely to be disallowed to begin with because there are ways to prove certain usage. For example, the mileage for driving to a landlord seminar in a distant city can be proven and various receipts would show that one made the trip, including those for buying gas along the way.

Most understand these facts and also know that the worst that will happen is that they will have to pay the taxes (plus some penalties) on a non-allowed portion of the deduction for one year in question. Many probably figure that they earned many, many times that amount for the hours that would have been spent on maintaining proper mileage logs during the 20 years that they were never audited.

However, considering the relatively little time and energy required for maintaining an adequate log, there is really no excuse for not doing so. As with other items related to a possible audit, having detailed records regarding a particular item being looked at by the audit can reduce the chance that the auditor will look at other items. Having inadequate records regarding your business auto deduction may encourage the auditor to look more closely at your records for other items, both income and expenses.

This article summarizes certain issues related to business use of a motor vehicle. For more detailed information regarding significantly more issues, see the appropriate IRS publications. For tax advice consult a competent tax advisor.

Some Questions & Answers

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Q1

Do you have information about the location where the mandatory “carbon monoxide devices” are supposed to be installed in the CA single-family home rentals per the new SB183 that is effective July 1, 2011? Some people recommend installing them on the ceilings while others say to install them on the lower half of the walls. My rental property is located in San Jose, CA.

A1

The text of the subject SB 183 can be found on the Web. Although I will provide some discussion regarding my understanding of the law, you should read and understand the law yourself, at least those portions that are relevant to your particular properties.

In brief summary, effective July 1st, 2011:

1)   All existing single family dwellings that contain a fossil fuel burning heater or appliance, fireplace, or an attached garage must install carbon monoxide alarms. In other words, unless you live in an all-electric home not having a fireplace with a detached garage and you don’t use a hibachi, you are covered by this law.

2)   All other existing dwellings (multi-family) shall comply by January 1, 2013.

3)   CO alarms must be either battery powered or plug-in with battery backup.

4)   CO alarms must be installed outside of sleeping areas and on every level of a dwelling, including the basement.

5)   If the device is a combined smoke detector and CO detector, the combined device must comply with the law for each type detector and the combined device must emit an alarm or voice warning that clearly differentiates between a carbon monoxide warning and a smoke warning.

6)   The devices must be ones that have been certified by the State Fire Marshall. It will be illegal to sell detectors that have not met the Fire Marshall’s certification requirements.

7)   With respect to the number and placement of carbon monoxide devices, the devices must be installed in a manner consistent with building standards applicable to new construction for the relevant type of occupancy or with the manufacturer’s instructions. Manufacturers must have their instructions approved by the state.

8)   The law creates disclosure requirements with respect to carbon monoxide detectors upon sale of a property.

As you are aware, there have in the past been differences in opinions and instructions among manufacturers and “experts” regarding which living spaces should have CO detectors and where they should be installed within a particular room, with opinions regarding the where to install them varying from “on the wall close to the floor” or “on the ceiling.” This has always been an important issue regarding combination smoke and CO detectors because some experts have considered that the two types have different optimum locations.

As seen in item 7 above, SB 183 does not itself provide installation instructions, but basically leaves it up to the State Fire Marshal. In general, past recommendations have been that CO alarms be installed on every level of a dwelling, including basements, and outside each sleeping area in the immediate vicinity of the bedroom(s). However, it is important that you obtain correct information for both the new state law and for any more restrictive local ordinance.

In my opinion, your best choice for obtaining correct information on this aspect of the subject is to inquire of governmental entities which are responsible for enforcing the state law and any local ordinance for San Jose with the issue and/or are responsible for enforcing the law. I would further suggest that you consult more than one agency that might provide such information in hope that the same answer from all or at least a majority of those consulted provide you with the same information, giving some confidence that you have the correct information. You should include the city (or county) building department, a couple of fire stations in the area, and any local rental housing agency. You might also see what kind of information you can obtain from your local landlord association(s) or any property management companies who are willing to respond to your request. I would also suggest that you attempt to obtain for your files printed materials regarding the subject from anyone providing information.

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Q2

I have a tenant who is a foreign born US citizen. Since he moved in, he married a young lady for whom he is trying to acquire citizenship. She has a social security number, but the credit reporting company could not find her. Is there any documentation I should ask for prior to signing her up on a lease amendment?

A2

The fact that a person has a social security number does not mean the person has a credit history with TransUnion, Experian, or Equifax. Reasons why a person will not have a credit record include:

• They have never obtained credit from a merchant or lender who reports to credit bureaus. Even if a credit event is reported to one credit bureau, it may take time before all credit bureaus have the information.
• A person may have always utilized cash or checks and never borrowed money (at least from a lender who reports to credit bureaus), obtained a credit card, or rented from a landlord who reports to credit bureaus (few landlords do) and, hence, may never have a record with any credit bureau.
• It may take months for a first credit event to appear at any credit bureau for someone who has only just recently obtained credit.

One may need to obtain a Social Security Number or Individual Taxpayer Identification Number for employment or tax reporting reason, but may never obtain credit. For example, someone who has significant interest income in the U.S. would need either a SSN or ITIN.

The above being said, “no record found” reports sometimes results from the fact that the SSN or ITIN and name that were provided were not correctly entered. It’s even possible that an applicant mistakenly provided an incorrect number. However, incorrect SSNs will often result in a report that indicates the number and name do not match.

Regarding documentation that should be required, all applicants (all co-tenants of legal age,  including spouses) should be screened using the same procedures; including verifying identity (potentially the most important item) and screening reports – e.g., credit reports, eviction records, criminal record reports, employment or business history, and previous landlord checks. When there is no information from one or more of the reports, landlords must evaluate the applicant from information received.

Finally, you should not hesitate to ask applicants why they have no credit record.

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Q3

As a landlord in the state of Washington, can I restrict my rental properties to be no smoking?

 A3

I cannot state that a particular rental property location is not subject to some unusual local ordinance related to prohibition of non-smoking rules, but I’d probably bet a lot of money against there being one. Nationwide, the trend has for years been to limit smoking. Many states have passed laws and many local governments have passed even more restrictive ordinances against smoking in public places. Some jurisdictions even prohibit smoking in bars.

Most basically, there is no law that prevents landlords and property managers from regulating smoking on the premises, whether inside individual units or outside in common and private use areas. This is because (1) there is no constitutional right to smoke and (2) smoking is not protected by federal Fair Housing laws and is very unlikely to be protected by any state or local laws. HUD does not prohibit non-smoking policies in affordable housing. In fact, in 2009 HUD released a memo that encourages public housing authorities (PHAs) to implement non-smoking policies.

In Washington State a number of PHAs have adopted non-smoking policies including those in King County Housing Authority, Wall Walla Housing Authority, and Clallam Housing Authority.

There is now increasing action against smoking by owners and managers of properties. Tens of thousands of apartments and condos have gone smoke-free in the past five years, including those managed by the owner and those managed by management companies. Some municipalities are passing ordinances related to smoking prohibitions, not only in public places, but also in multi-unit housing.

Many landlords prohibit smoking in their units rather than discriminate against smokers per se because it is the act of smoking in the unit rather than the fact that a tenant is a smoker that is important. Most, perhaps all experts feel that owners have the right to protect their properties against damages from smoking and to protect other occupants from secondhand smoke. However, now the problem becomes one of detecting violators without running afoul of privacy rights. The solution is to both prohibit smoking inside of units, as well as on associated patios and balconies, and to make tenants responsible for damages resulting from failing to adhere to the prohibition.

This requires that applicants first be made aware that the unit is a non-smoking one in order to avoid wasted time and money in processing applications for those who might be unwilling to sign a lease that includes non-smoking provisions. Upfront notice can be accomplished in advertising, in an information sheet attached to the application form, or within the application form itself.

The lease agreement should, of course, contain very specific clauses related to the non-smoking issue. In addition to a clear statement of the prohibition, acknowledged by the tenant upon signing the agreement, the lease should also set out in some detail a list of damages resulting from smoking for which a violator will be responsible. The list would include items such as burns or stains on any component of the unit, odors, smoke residue on any surface, and potential other liabilities such as damages resulting from smoking-related fires.

The lease agreement should clearly make the tenant responsible for the cost of repairing, cleaning, painting, or replacing any items so damaged. Of course, the tenant must be initially provided with a unit that has no evidence of previous smoking-related damage or such previous damage must be noted in the move-in checklist.

For multi-unit properties, prohibiting smoking inside units and in common area hallways and within some distance of residents’ patios, balconies, doors, etc, can actually reduce the risk of problems

Because second hand tobacco smoke is often considered a nuisance in the same way that loud noise would be considered a nuisance, if tenants are complaining about drifting tobacco smoke, landlords must take action to protect them. Landlords and property managers who fail to accommodate non-smoking tenants who complain about secondhand smoke may be exposing themselves to lawsuits. If a resident or prospective resident has a disability or chronic illness which is made worse by exposure to tobacco smoke, Fair Housing Laws will require a ”reasonable accommodation.”

Holding Deposits

Sometimes, when the rental market is tight, applicants may offer a holding deposit to take the rental unit off the market until the applicant’s screening and verification is complete. Other times, a holding deposit may seem appropriate when an applicant appears committed to the rental, but must make arrangements for the move-in funds. The holding deposit is not a security deposit, but is to compensate the landlord for damages suffered for holding a unit off the market in the event that the applicant fails to meet screening qualifications or rescinds his/her agreement to rent the unit.

It is best to avoid the use of holding deposits, particularly now that most verifications of qualification can usually be done within a relatively short time utilizing today’s technology. Although holding deposits may be legal in your state, they often lead to misunderstandings or even legal hassles. A major problem is that most states do not cover the subject adequately, if at all, and it is often unclear regarding how much of the deposit may be retained by the landlord in the event screening results are unsatisfactory or the applicant cannot come up with the necessary funds or simply changes his mind about wanting the unit.

Some states that cover holding deposits by statute specifically allow a landlord to retain an amount related to the landlord’s cost of holding the unit. This might include the costs of additional advertising, prorated rent for the holding period and perhaps a reasonable charge for the time related to paper work and inconvenience to the landlord, but holding a larger amount puts the landlord at risk for a lawsuit. Some states specifically require that there be a written contract that states the terms and provides a receipt for the amount.

Although holding deposits are best avoided, sometimes they are helpful because of market conditions. If allowed by your state, it might be better to utilize a holding deposit rather than lower qualifying standards or reduce the rent. For the landlord’s protection, holding deposits should always be in cash, cashier’s check, or money order and for the protection of both parties there should always be a written agreement detailing the conditions related to the deposit even if not required by law.

When the landlord holds the rental unit for an applicant, it should be considered off the market and unavailable to other qualified prospective tenants who may have to be turned away. If the applicant later changes his/her mind, the landlord may have suffered financial harm. In such a case, the landlord is justified in retaining all or part of the holding deposit within the limits allowed by state law. However, be sure that this scenario is discussed in a signed agreement.

The amount of the holding deposit should be reasonably related to the rent of the unit and should take into account the potential inability of some applicants to immediately put up significant deposit funds in addition to application and/or screening fees.

The written holding deposit agreement should be in accordance with any applicable state law and unambiguously cover the following issues:

• The address of the rental unit,
• The names of landlord and applicant,
• The amount of the deposit,
• The length of time (including exact ending date) the landlord is willing to hold the rental, taking into account the size of the deposit and other qualifying information,
• The basic terms of the lease agreement,
• The conditions under which the landlord will rent the unit to the applicant – e.g., verification of identity, a fully completed application form, satisfactory results on all applicable screening reports, verification of employment, and full payment of the security deposit and first month’s rent by the end of the holding period,
• What will happen to the deposit if the applicant signs a lease agreement – usually, that the full holding deposit will be credited to the security deposit,
• What will happen if the applicant decides not to rent the unit before being notified whether or not his/her application has been approved,
• What will happen to the holding deposit if the applicant fails to pass screening – usually the full deposit should be returned if the failure is evident within a couple of days after the landlord has accepted the holding deposit, and
• What will happen to the holding deposit if the applicant defaults on the holding agreement – specifically, how much the landlord will retain, this being in accordance with any applicable state law, and when and how the portion not being retained by the landlord will be returned to the applicant.

Possible clauses in the agreement might be written as follows:

• After the applicant has been notified that he/she has been approved to rent the unit and the applicant fails to complete the rental transaction for whatever reason, then the amount of damages to be deducted from his/her holding deposit shall be $____­____ per day from the date he/she agreed to rent the unit (the day the unit was taken off the market) until the day he/she gives notice of his/her rescission plus an equal number of additional days to compensate for lost marketing time and additional advertising expenses incurred.
• If the landlord’s damages exceed the amount of the holding deposit, then applicant agrees to pay the difference, to a maximum amount of $________, within _____ calendar days of request.
• In the event the landlord re-rents the unit within the time frame for which deductions have been made from the holding deposit, then the applicant should be credited an amount equal to the daily rent stated above for each day that rent was collected for the unit, with when and how the portion not being retained by the landlord will be returned to the applicant.

In summary, landlords and agents must follow any laws of their states and they should use good judgment and be fair in their holding deposit policy. An applicant whose holding deposit is retained without adequate justification may well have a cause of action for damages against the landlord which can result in more time and expense than the deposit was worth.

Some Questions & Answers

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Q1

Is there any legal reason why a landlord would not be able to take a copy of a prospective tenant’s SS card and driver license?

A1

The shortest answer is No! A longer short answer follows.

A landlord can request and make copies of any documents considered material to making an informed business decision. I considered the two items you mentioned to be at the top of the list and the minimum of what should be required. That being said, however, there are at least a few caveats.

First, as with most issues related to landlording, it is important that the same procedures be followed with all applicants, at least for a particular vacancy. Better yet, the procedures should not be changed every time there is a vacancy, but should be followed for a significantly long period, with changes being justified by changing business conditions such as supply/demand in the rental market. The policies and reasons for change should be documented and retained for at least the statutes of limitations of relevant statutes, ordinances, and regulations related to fair housing and other discrimination issues.

Second, a landlord will be safer to ask for two (or more) ID items out of a possible list of four or more items. It is important however to choose items that are relevant and material to identity verification and any other misrepresentation or fraudulent activity against the landlord or others. There are potential legitimate reasons why an applicant cannot come up with a requested document.

Third, landlords must be concerned about security of any such documentation – both computer and paper records – to avoid potential liabilities related to identity theft.

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Q2

I have a tenant whose dogs destroyed the carpet….it was so bad I had to seal the floors and a portion of the walls because the odor was horrific. What can I legally charge her? The carpet was 2 years old when she moved in and her tenancy was almost 6 years. It was expensive carpet as I had previously lived in the house [like 20 year carpet].

The new carpet I put in is 10 year at the cost of $1750 plus $250 to tear it out. Can she be charged the full $2000 or a pro-rata amount? It looks like I will be going to small claims on this one…appreciate your advice.

A2

Technically, charging a tenant the full replacement cost for any major building component would be unfair because the landlord had some period of benefit for the component – in your case, 8 years as I understand the facts. Most states do not have a specific statute regarding the issue, but many tenants are aware of the issue and many judges would not allow charging full replacement cost if the matter went to court. Probably few, if any, judges would allow it if the issue were raised by the tenant or an attorney for the tenant.

You are correct that the charge must be prorated. The tenant can be charged only for the expected remaining life of the carpet had it not been damaged by the tenant. The tenant should be charged for the fraction of replacement cost calculated by dividing the expected remaining life by the expected useful life of the particular carpet being replaced. However, when replacing any component with one of lesser or greater quality, there are potential issues that can be raised, the most basic issue being charging the tenant for something of higher quality than what the tenant damaged.

For a 20-year expected useful life and 8 years of use, the tenant would be charged for 12/20 of the replacement cost. For a 10-year expected useful life, the tenant would be charged for 2/10 of the replacement cost. Hence, the manner of calculation is quite important.

However, in view of the fact that a 10-year life carpet is replacing a 20-year life carpet, the tenant or her attorney could raise some issues. First, one could reasonably question if the 12/20 fraction can be applied to the 10-year replacement carpet cost. One might argue that the 12/20 needs to be applied to the cost of the original carpet. One would almost certainly insist that using the 20-year life requires proof that it really had an expected life of 20 years. One might also argue that the useful life of a normal rental grade carpet is 10 years and that the tenant should not be penalized for the fact that a higher quality carpet was used because it was your personal residence at the time of installation. Accordingly, a judge might agree that the 2/10 fraction must be used. Finally, the tenant might claim that the carpet looked like it had a lot more than 2 years use at the beginning of her occupancy and you may need proof of condition such as the move-in checklist, photos, and/or a witness.

Since 2/10 of $2,000 is $400, whereas 12/20 of $2,000 is $1,200, there is a significant difference in the charge. The tenant is more likely to argue the issue for the greater amount compared to the lesser amount and the risk of you losing in court probably increases with the amount involved.

It is possible that you would get away with using the 12/20 fraction because the tenant does not contest the matter or, if she does, isn’t represented by an attorney, doesn’t herself come up with good arguments, and you’re before a judge who doesn’t care. You will need to decide whether to use the smaller fraction (that you can likely successfully defend in court) or go for the maximum, assuming that the worst will be the lower of the two fractions (not necessarily true if the judge decided you were trying to cheat the tenant).

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Q3 (continuance of previous Q2)

This one will go to small claims court. What can I charge for my time? I have spent approx 40 hours cleaning. All tile grout had urine stains and needed to be hand-scrubbed….couldn’t hire anyone to hand-scrub. Can this be reasonably accounted for?

 A3

What would be considered reasonable – assuming anyone raises the issue – will depend on the type of work (including skill level & physical requirements), the local economy, and the particular judge. I think $20 to $30 per hour would be considered reasonable in most jurisdictions, with CA being on the high side compared to MS. You could consider using a number in the high twenties, as it will not seem as high as $30. There’s a reason why most merchants price something at $29.99 rather than $30.00. You could use $27 or $28 so as not to appear too cute. You will also want to have a written log detailing your work, logging time in tenth-hour or 10-minute increments. The hourly rate is probably more debatable than the number of hours because data can be found supporting lower levels of pay than you would want to work for, whereas, it’s harder to prove the hours required for such work, particularly as cleaning time depends on a number of issues including the type of dirt/stains, the item and type of material that is dirty/stained, and the worker’s knowledge of cleaning products. Accordingly, a judge might look more favorably on billing for more hours at a lower hourly rate, particularly when you can show a realistic looking detailed log.

Expenditures – Part 2

In a recent newsletter (Expenditures – Part 1) we discussed some basic principles regarding expenditures including those that (1) may be deducted in the year made, (2) must be capitalized, (3) must be amortized, and (4) must be added to basis. In this newsletter we continue the discussion of expenditures by considering in more detail some of the specifics related to deductible expenditures.

As stated in Part 1, to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

Those expenditures that may be deductible in the year paid include the following:

• Advertising and other marketing of the rental property
• Cleaning & maintenance of the property
• Utilities serving the property
• Insurance of all types related to the property
• Taxes of many types related to ownership and operation of the property
• Rental payments to others for equipment or real estate related to the rental property
• Employee overhead
• Interest on loans, whether for the subject property or for equipment used for the property
• Mortgage Points (although not all)
• Management fees or leasing commissions paid
• Tax return preparation fees directly related to the property
• Travel expenses related to the property or management thereof
• Auto or other local transportation expenses related to management or maintenance

Some of these items require discussion beyond what was said in Part 1 of this series because they are more likely than others to raise issues in income tax audits.

Repair & Maintenance Expenses

Expenditures for repairs and maintenance, both labor and materials, are deductible in the year paid. Items charged to a credit card can usually be deducted n the year posted to the card account even though paid in the next year or over multiple future years.

Whether an expense is a repair or maintenance is usually immaterial and some events can be considered to be one or both. A repair expense is usually considered an expense incurred in order to restore an item or a system to its previous condition. As examples, replacement of the washer in a leaking faucet or replacement of a relatively small number of shingles would usually be considered to be repairs. A maintenance expense is usually incurred in order to keep a rental property component in good condition. For example, interior and exterior painting expenses are usually deductible in the year paid.

Capitalized Expenditures – Improvements

You must capitalize rather than deduct some expenditures. These costs are a part of your investment in your business and are called “capital expenses.” Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.

1. Business start-up costs
2. New business assets
3. Improvements and restorations

For an ongoing rental property, improvements are usually the most common expenditure that must be capitalized. An improvement is work that adds something new to an existing property or makes it better than it was. It is an expense that is incurred to make the property more valuable or to allow for increased rent. Further discussion of improvements and restorations will be included in Part 3.

You cannot deduct the cost of improvements. You must separate the costs of repairs and improvements and keep accurate records of each separately. The cost of an improvement must be capitalized. You recover the cost of improvements by taking depreciation as if the improvement were separate property. You will need to know the cost of improvements when you sell or depreciate your property, as the cost less the portion depreciated prior to sale are added to the basis of the property, reducing the gain from the sale.

Employee Overhead

As you probably expected, not only is the salary or hourly wages of employees who perform management and maintenance work deductible, but all overhead costs associated with those employees are also deductible. Included in such overhead is unemployment insurance, workers’ compensation insurance, the employer one-half of Social Security and Medicare taxes, and health insurance premiums paid by the employer.

However, both wages and overhead associated with improvements would have to be capitalized along with materials and other costs of doing capital improvements just as for capital improvements made by independent contractors.

Interest Expense

You can deduct interest paid on a mortgage or other loan related to your rental property. You cannot deduct interest paid in advance beyond the tax year. If you paid $600 or more of mortgage interest on your rental property to any one person or entity, you should receive from the lender a Form 1098 Mortgage Interest Statement showing the interest you paid for the year.

Expenses Paid to Obtain a Mortgage

Certain expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. These expenses, which include mortgage commissions, legal fees, abstract fees, title insurance premium, and recording fees, are capital expenditures that you can usually amortize over the life of the mortgage.

Points – The term “points” is often used to describe some of the charges paid by a borrower to take out a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges, or premium charges. If any of these charges (points) are solely for the use of money, they are interest. Points paid when you take out a loan or mortgage result in original issue discount (OID). In general, the points (OID) are deductible as interest unless they must be capitalized. How you figure the amount of points (OID) you can deduct each year depends on whether or not your total OID, including the OID resulting from the points, is “insignificant.” If the OID is not insignificant, you must use the constant-yield method to figure how much you can deduct.

Loan or Mortgage Ends

If your loan or mortgage ends, you may be able to deduct any remaining points (OID) in the tax year in which the loan or mortgage ends as well as any other costs related to financing that were being amortized. A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. However, if the refinancing is with the same lender, the remaining points (OID) generally are not deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage or loan.

Travel Expenses

You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. This will usually include educational costs related to investing in and managing income properties. You must properly allocate your expenses between rental and non-rental activities. You cannot deduct the cost of traveling away from home if the primary purpose of the trip was the improvement of your property. The cost of improvements is recovered by taking depreciation.

Local Transportation Expenses

You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: (1) actual expenses allocated to business use according to the percentage of miles driven for business compared to total miles driven for the year or (2) the standard mileage rate for the business miles. For 2010, the standard mileage rate cars, vans, pickups, or panel trucks was 50 cents a mile for all business miles and for 2011, the rate is 51 cents a mile.

To deduct vehicle expenses under either method, you must keep records that follow the rules in chapter 5 of IRS Publication 463. In order to determine the percentage of vehicle expenses or mileage that are business related and support the percentage in an audit, it is important that a log be kept. The log should include beginning and ending odometer mileage for each business related trip.

Payment for Goods & Services

Landlords are required by law to provide 1099 forms for payments totaling $600 or more in a calendar year made to unincorporated businesses for services.

Most landlords often use unlicensed contractors and many of these vendors will not qualify as independent contractors under an audit. Furthermore, many landlords do not utilize 1099s as required by law. While 1099s are required for both licensed and unlicensed non-corporate contractors, failure to use 1099s for unlicensed individuals carries greater risk because licensed contractors are much more likely to possess other characteristics that are considered by the IRS when the issue arises regarding whether a worker is an independent contractor or an employee. Without going into all the details about the potential penalties for improper classification, suffice it to say that all items required for employees – including income tax withholding, social security payments, unemployment insurance, and workers’ compensation insurance – are potentially costly items that can include back payment for those items that would have been required for an employee as well as stiff penalties and interest.

While filing 1099s does not make the worker an independent contractor, the fact that the worker received a 1099 and knows the landlord will file the information with the IRS and the state should increase the odds that he/she will report the income on his/her income tax returns and reduce the chance that the worker might file claims for workers’ compensation or unemployment payments, two of the events by which the possible misclassification of workers becomes an issue.

Some Questions & Answers

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Q1

Can I ask a tenant to move out (in 30 days) so that needed work may be done on their unit? No current lease or rental agreement is in effect.

A1

There is always a lease or rental agreement in effect. If there is a written document, it likely has a clause that makes it a month-to-month tenancy upon expiration of the original term. If there was no written document, it is an oral lease agreement, with terms that were agreed by the parties and, if it goes to court, the terms that are best proved by circumstantial evidence or whichever party is the better liar.

However, the above being said, if the lease is currently month-to-month, most states do require a 30-day notice of termination. Some states require a longer notice period under certain circumstances. In most (not all) states, no reason for termination need be provided to the tenant and it is usually best to not provide one that might be turned into a fair housing complaint.

Even if there is no written documentation, you should definitely give a written termination notice and serve it in a manner that provides proof of service. This can be either by delivering it in person or via Certified Mail. In either case, it is best to also mail a copy of the notice via a Certificate of Mailing, a PO service that provides the sender proof of mailing without giving the recipient a chance to reject acceptance of Certified Mail.

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Q2

I want to evict tenants (Oregon). How do I do it? They are new tenants that have violated the terms of the lease by having more people and by smoking in the unit, both things not allowed.

A2

What you can do depends on clauses in your lease agreement. The fact that they are new tenants would usually be irrelevant. What counts is whether the tenants materially violated one or more unambiguous clauses in the agreement. If they are month-to-month tenants you can simply terminate the lease with 30 days notice without any reason being given. You could also increase the rent with 30 days notice to allow for damages.

Assuming that they did default on the lease agreement, you will first need to properly serve them with a “cure or quit” notice (not necessarily the exact legal name under Oregon landlord-tenant law). I do not think Oregon allows for an “unconditional quit” notice for such violations as you list, so you cannot necessary evict them. A “cure or quit” notice in Oregon must give the tenants 14 days to cure the default and an additional 16 days to vacate (10 days to remove an illegal pet). If the default is not cured within the 14 days and the tenant has not departed within the following 16 days, you can then begin an eviction action.

Practically speaking, the defaults you mention, as I understand your limited description, are such that they may already be no longer in default. Obviously, they could again commit such violations, always curing them before the end of 14 days after notice. Accordingly, you need to always immediately serve the notices upon first knowledge of the violations. If there are a number of repetitive provable occurrences, it is likely that a judge would allow an eviction even though the violations are always cured within 14-day period. This is something that you could ask of an attorney who regularly does evictions in the court of jurisdiction and such an attorney would likely have a good idea of how many such repetitions might be required.

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Q3

On 6/4/11 the City of Chester, Pa notified me that I am delinquent in payment of the 2000 and 2001 Trash Collection Fees for my rental property. This is my only notification from the city. Is there a Statute of Limitation on this bill?

 A3

It is my understanding that there are four categories of debt collections and each has their own statute of limitation under Pennsylvania law. For oral agreements it’s four years, for written agreements it’s six years. For contract notes (such as mortgages) it’s four years, and for open accounts (such as credit cards) it’s six years. After these periods expire, the creditor can still request payment, however, he usually has no potential for punitive action recovery – i.e., via a lawsuit.

I would think that a city trash collection account would have required a written agreement when signing up for service, but such is not always true. However, since 2001 is considerably longer ago than the longest statute of limitations period, the category is likely immaterial.

The fact that this is your first knowledge of the debt may be irrelevant and a judge may believe the city over you if it claims that not to be so – after all, government entities are considered by some to be efficient and truthful.

The above being said, when dealing with a government entity, there may be other issues. For example, the entity might have a lien right against the real estate and such a right might not be subject to statute of limitations periods. It is possible that a government entity is specifically exempted from the statute of limitations laws even if it doesn’t have a lien right.

You do not specifically mention whether the account was in your name or in the name of a tenant, with the city attempting to collect from you even though you did not agree to the account. The latter is allowed in some jurisdictions, but not in others. From the wording of your question, I’m not certain that the alledged delinquency occurred during your period of ownership.

You also do not mention the amount of the city’s claim or whether they are including possible late charges and/or interest for all those years. The first thing you need to do is decide whether the amount the city claims you owe is worth fighting about, particularly if the amount is greater than the maximum small claims amount allowed, which I believe is $8,000 in PA, except for Philadelphia where it is $10,000. If the city’s total claim is for less than this amount – and I certainly hope it is – you could test things in small claims court at relatively little cost, even if you first spend a relatively few dollars for a consultation with a competent attorney experienced in the subject matter. If the claim does not qualify for small claims court, the cost of contesting it will increase substantially. When dealing with government entities it must always be remembered that they have essentially unlimited taxpayer funds (some coming from you) and likely have staff attorneys who may have less than enough to do to justify their salaries. It’s possible that you could even be subject to city legal costs if you lose.

There may be other issues that are material to the problem.

If you have not sat down with the appropriate city trash collection person, preferably someone at the supervisor level, I suggest that you do so in order to determine just what their options are (e.g., do they claim to have lien rights), how aggressive they intend to be, and whether some significantly reduced settlement is possible. After you fully understand the city’s position, you can decide what to do next.

A Tip for Better Rent Collection

Never Give the Tenant a Reason Not to Pay Rent

Collection of rents is arguably the most important issue related to property management. Most landlords depend upon the monthly rent to cover mortgage payments, property taxes, and other property expenses. When tenants fail to pay rent, these landlords may find themselves scrambling to cover these expenses.

First and foremost – follow the law. The legal relationship between landlord and tenant is spelled out in state statutes, local ordinances, safety and housing codes, common law, contract law and case law. Each party has obligations to the other that must be fulfilled. Both landlord and tenant have a duty to treat each fairly and to act in good faith.

Of particular importance are two rights given to tenants under law that could affect the landlord’s ability to collect his rent. The implied covenant of quiet enjoyment is basic to all leases. It ensures that the tenant’s possession of the property will not be disturbed by the landlord acting or failing to act in a manner that seriously interferes with or destroys the ability of the tenant to use the rental premises.

The implied warrant of habitability provides the tenant decent and sanitary rental housing at the time of rental and throughout the tenancy. A breach of this warrant violates housing codes and may cause constructive eviction of the tenant, allowing the tenant under statute to withhold rent, repair and deduct damages from the rent, and/or recover other damages.

It is possible for both rights to be violated at the same time. For example, if the landlord causes the rental premises to become uninhabitable, such as allowing unsanitary conditions, waste, or nuisance, the landlord has committed a breach of the lease agreement and may have caused constructive eviction of the tenant. By his breach, the landlord may have given the tenant the right to withhold rent, terminate the lease, or both.

Disputes between landlords and tenants must be resolved by prescribed legal means, not through unilateral actions.

State laws govern most rent issues and the laws vary significantly among the states. There may be statutes regarding the amount of rent that can be charged (in rent control jurisdictions), the amount of deposit that can be required, when and where to pay the rent, grace periods, late rent charges, returned check charges and rent increases. These laws will apply unless the landlord’s lease agreement stipulates different conditions that are not in conflict with the laws. Once the landlord understands what is required by applicable landlord-tenant statutes, he can write his lease agreement to meet or exceed legal requirements in order to better protect his business interests including collection of rents.

A landlord must thoroughly understand his lease agreement and apply the lease terms uniformly and firmly to all tenants who have signed that lease agreement. While the landlord holds the tenant responsible for the terms of the lease agreement, the landlord must hold himself equally accountable under the lease agreement for his duties and responsibilities.

The lease should clearly define all issues related to rent in order to avoid misunderstandings and disputes with the tenant at a later date, perhaps when the payment of rent has already become an issue.

The lease agreement should have clauses that clearly address the issues of:

• Amount of rent
• Due date
• Grace period, if any
• Type of funds
• How/where to pay
• Late charges
• Returned check charges

Lease agreements must include tools for enforcing timely payment of rents and management of the property. For example, if default provisions aren’t adequate, the landlord may be unable to evict a tenant who defaults on rent payments or other lease obligations.

Communication about rent rules is crucial to getting the rent money. Clearly defined rules help the tenant understand what is required and the consequences of non-performance. Landlords must not be afraid to ask for their money and to follow through with appropriate action if the tenant defaults.

There are some landlords who, as long as they receive the rent within a week or two of the due date, don’t make a big fuss about rent collection. They allow the tenant to develop bad payment habits by not enforcing the landlord’s own rent rules. Lackadaisical behaviors by landlords contribute to unwanted tenant behaviors. If rent collection is not important to the landlord, it will not be important to the tenant. Some tenants take maximum advantage of permissive rent collection. Until rules are enforced by applying consequences to undesired behaviors, the tenant will remain convinced that if he ignores the landlord’s requests the landlord will go away and perhaps even forget about it. Control has passed from the landlord to the tenant. Professional property managers recognize this issue and have standard procedures in place to fairly and consistently enforce the rules for all tenants. Tenants obey the rules because there appear to be serious consequences.

The process of evicting a tenant for nonpayment of rent is usually among the quickest and most streamlined of all legal proceedings in most states, assuming the legal procedures are properly followed in a timely manner. A common mistake is that the landlord delays taking action against tenants when they default on their lease or cause problems for other tenants. A “pay or quit” notice should usually be served on a tenant the day after the rent is due or after any grace period provided in the lease or by law. If the tenant fails to pay by the end of the notice period required by state law the landlord should immediately begin eviction.

Landlords are justifiably concerned that serving the “pay or quit” notice immediately may alienate the tenant or create unwanted disputes about maintenance or other issues regarding the tenancy. They hope that waiting to serve the notice, on the other hand, may allow the problem to resolve itself because the tenant will eventually pay the late rent.

However, it is best to serve notices as soon as possible. The landlord can always waive the notice if the tenant pays the rent and applicable late charges or cures any other default and can always terminate the eviction process if the problem is resolved only after proceeding to court. Delaying action only increases losses in the case of a tenant who will never again pay the rent and will cause additional financial and/or other problems for many other types of defaults. For example, the longer a tenant is allowed to disturb other tenants, the more likely good tenants will be leaving.

Furthermore, if a landlord doesn’t routinely serve the notice immediately each time a rent is past due, a tenant could claim during the eviction proceedings that the landlord “waived” the right to receive the rent on the first of the month or that you orally “worked a deal” for rent to be paid late. The tenant can even claim that the lease has been permanently modified and that the landlord can no longer demand the rent on the first of the month because he accepted the rent late and did nothing in the past.

When you always serve the “pay or quit” notice promptly you maintain complete control of whether to allow the tenant additional time to pay the rent or not. There should always be a written agreement when giving permission for late payment.

Some Questions & Answers

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Q1

Can you provide information on foreclosure vs. short sale for rental properties we own and cannot get the loan modified to rent?

A1

You have asked a question which would require thousands of words to adequately answer because there are several separate primary issues involved and each potentially involves a number of secondary issues. Primary issues include impact on credit record, income tax consequences, and, depending on the state and other factors, the possibility of deficiency judgments from lawsuits against you by the lenders.

I will briefly discuss some of the issues, but for a complete understanding of all the issues using adequate facts related to your particular situation and for your particular state, I strongly advise you to consult with a competent real estate attorney of your state and with a CPA or other competent tax advisor.

Credit Record

Lenders will almost certainly report both foreclosures and short sales to the credit bureaus. In calculating credit scores, every negative on a credit report is assessed by three factors: how recently the negative event occurred; the severity of the negative (how late is the payment); and the frequency of negatives (how many times you’ve been reported delinquent on credit obligations).

A recent bankruptcy does the most damage to your score. If lenders report all of your mortgages as in default, the damage to your credit score would be akin to declaring bankruptcy on all accounts.

Although a short sale, where the lender agrees to take less than owed on the mortgage, will drop your credit score as much as will a foreclosure, there is one advantage to it  when a principal residence is involved. This is that you may be eligible to buy a home with an institutional loan backed by Fannie Mae or Freddie Mac more quickly than you would if it went into foreclosure. Borrowers can be considered for loans after 24 months following a short sale if the sale was caused by extenuating circumstances outside of a borrowers’ control, or after 48 months if it was the result of financial mismanagement by the borrower.

The manner in which title to properties are held could affect the impact on your credit score.

Income Tax

The Mortgage Forgiveness Debt Relief Act of 2007 and the recently passed Emergency Economic Stabilization Act, provides for exclusion of up to $2 million of income ($1 million if married filing separately) from debt that’s discharged through mortgage restructuring, or that’s forgiven in connection with foreclosure, for the years 2007 through 2012. The exclusion must be connected with a decline in the home’s value or the taxpayer’s financial condition, and only applies to a principal residence, not investment properties.

There may be other provisions in the law that can help. For example, some or all of that debt may not be taxable if one is insolvent when the debt is cancelled.

Again, the manner in which title to a property is held could affect income tax consequences.

Deficiency Judgment

Depending on the state, there may be the possibility of lenders filing lawsuits and obtaining deficiency judgments following foreclosures. There may also be the same possibility for short sales, so it is important that there be an anti-deficiency clause in the short sale agreement. Since lenders generally net more from short sales compared to foreclosures, they are usually willing to agree to no deficiency action. A few states may prohibit deficiency judgments by statute (modified by court cases). For example, Arizona prohibits deficiency judgments for purchase money loans on one- or two-family homes on no more than 2 acres. For Arizona, the law applies to either one’s personal residence or for rental units.

Again, the manner in which title to properties are held could affect deficiency judgment risks.

Other Options

Some states may provide for other options, so, again you need to seek advice from competent professionals. Competent real estate agents who do significant short sale work may be able to provide information about any state benefits.

Depending upon the specific financial numbers related to particular properties, a lender might also be open to accepting a deed in lieu of foreclosure. This will also have potential income tax consequences and may affect your credit record, but it can be the best solution when possible.

Conclusion

As seen from my very brief discussions of a few of the possible issues, it is important that you make decisions based on your particular situation and on the laws of your state. Given the complexity of the subject, do not attempt to deal with this situation on your own.

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Q2

The tenant that signed the lease (WA state) has a girl friend that will be moving in in a month. Should we have her sign the lease and run a check on her also? What are the benefits and the downside?

A2

The basic rule is that every adult (18+ and emancipated minors) who will reside in a unit should have been checked using every screening method used for any applicant – i.e., identity verification, credit report, eviction record search, criminal record search, and inquiry of previous landlords. This applies to both original applicants and those added at a later date. Every adult applicant should be required to sign the lease, both original occupants and those added later.

Identity verification is a primary screening mechanism, as it is of no value to end up with great reports on an identity thief. Also, a credit report alone is not sufficient, as a convicted drug dealer who is successful in his business and would continue in his business while residing in your rental unit can have an excellent credit record and pass all other screening checks.

Screening every potential occupant reduces the chance of ending up with a very bad tenant if/when the only screened one skips, dies, or files for bankruptcy. Requiring every adult occupant to sign the lease provides additional people to go after if there are later problems, as each lease signatory should be jointly and severally liable for the terms of the lease, including for unpaid rent and damages. Also, having adequately screened each lease signatory provides information that can be useful if/when occupants skip.

Screening every occupant and requiring each one to sign the lease has many upsides. I know of no downside. There are likely landlords who purposely do not have all occupants sign the lease because they mistakenly think it will be easier to evict the non-signing occupants if ever necessary. However, such is not the case because they will have to be removed via eviction if they choose to not voluntarily leave when the lease expires or has been terminated for cause by the landlord, just as will the occupants who signed the lease. The cost of screening should not be a reason to avoid it, as most states allow landlords to charge for processing of applications, including screening and, even when in a state that restricts how much can be charged, the cost is relatively negligible. The time and money for adequate screening are both a lot less than the cost of a trashed unit.

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Q3

My tenant painted the exterior wall without my permission. She wants me to pay for the cost, but on rental agreement she signed indicated that tenants shall not paint, wallpaper, add or change, etc. without owner’s prior written consent. What is the best way to refuse her? Please advise.

A3

Assuming that the lease clause you mention is adequately stated, you should not need to even consider reimbursement for the painting. In fact, if the painting is unacceptable to you – due to color chosen, quality of workmanship, or other reason – you could probably require that the tenant pay you for the cost of correcting the work or even returning the wall to its previous condition. Depending on a number of factors you might even be able to terminate her lease if you wished. However, even if you did not provide written permission, anything you had said related to the matter that may have implied permission, even your prior knowledge of intent to perform the work and not actively protesting the work could negate your right to take such actions against her. In deciding how far to push their rights, particularly when the Landlord has not been significantly damaged, Landlords must always consider that judges do not always worry about legal technicalities. That is, the judge may consider oral notice without your protest to be acceptable in spite of the lease’s requirement of written permission.

Assuming that you did not in anyway orally agree, either explicitly or by implication, that she would be reimbursed, you can simply give her a written notice that she has violated the terms of the lease and that you will not be reimbursing her for the painting. If the work is unsatisfactory and you want to attempt to charge her for the cost of correcting it, you could include that information in the same notice.