Matt Engel is our guest writer for today.  Matt is an attorney and a Minnesota Real Estate Show radio partner.

Q: “I have a new tenant who will pay the first and last months rent in advance due to bad credit.  If they are late on a month can you still evict or do you wait until the next month?  Do you use the advance payment if they are late or hang on to it and insist on payment for that month?  What is the standard use of this last month paid in advance?  How do you handle it if you get to the end of the lease and want to extend?”

A: I am not aware of a specific section of the landlord tenant statute that deals directly with advance rent payments.  However, Minn. Stat. 504B.178 deals with interest on security deposits; withholding security deposits; damages; and limits on withholding the last month’s rent.

The reference to the limit on withholding the last month’s rent is actually addressing the tenant’s withholding the last month’s rent in lieu of the security deposit, as opposed to an advanced rent payment.

I would argue that the advance rent payment is an exception to the application of this statute section per the following language in Minn. Stat. 504B.178:

Subdivision 1. Applicability. Any deposit of money, the function of which is to secure the performance of a residential rental agreement or any part of such an agreement, other than a deposit which is exclusively an advance payment of rent, shall be governed by the provisions of this section.

Therefore, I would argue that section 504B.178 does not apply to the last month’s rent payment because it is an advance payment of rent.

For learning purposes, let’s take a look at the provision that discusses withholding rent.  The relevant portion dealing with withholding rent states:

Subdivision. 8. Withholding rent. No tenant may withhold payment of all or any portion of rent for the last payment period of a residential rental agreement, except an oral or written month to month residential rental agreement concerning which neither the tenant nor landlord has served a notice to quit, or for the last month of a contract for deed cancellation period under section 559.21 or a mortgage foreclosure redemption period under chapter 580, 581, or 582, on the grounds that the deposit should serve as payment for the rent. Withholding all or any portion of rent for the last payment period of the residential rental agreement creates a rebuttable presumption that the tenant withheld the last payment on the grounds that the deposit should serve as payment for the rent. Any tenant who remains in violation of this subdivision after written demand and notice of this subdivision shall be liable to the landlord for the following: (1) a penalty in an amount equal to the portion of the deposit which the landlord is entitled to withhold under subdivision 3 other than to remedy the tenant’s default in the payment of rent; and (2) interest on the whole deposit as provided in subdivision 2, in addition to the amount of rent withheld by the tenant in violation of this subdivision.

Now that we know that a tenant is prohibited from withholding the last month’s rent on the grounds that the security deposit should serve as payment for that rent, let’s get back to the discussion on advance rent payments.

I found a Minnesota Supreme Court case from 1921 that discussed advanced rent payments – and it actually states that the landlord can retain an advanced rent payment if the tenant breaches the lease prior to the time when that advanced payment was to be used.  Here is the language from that case:

Where a lease is terminated for a default of the tenant after he has made an advance payment of rent, the landlord is entitled to retain such advance payment, although the lease was terminated before the beginning of that part of the term upon which such advance payment was to be applied.

Thomas Peebles & Co. v. Sherman, 148 Minn. 282, 283-84, 181 N.W. 715, 716 (Minn. 1921).

Although this case sounds promising to landlords, especially those landlords that collect the first and last month’s rent, I think its usefulness would apply more to a well briefed court battle as opposed to the simple confines of the housing court.  In other words, I don’t think a housing court referee will force a tenant out of their home when they have a month’s worth of rent on advance to the landlord.  What’s the trade-off?  The person making the Peebles argument is attempting to keep the last month’s rent, and risking the time, effort, filing fee, and service fees if the case is dismissed by the housing court.    Probably not a good investment.  It should also be noted that the tenant breach in the Peebles case was for violation of the non-subletting clause, not for non-payment of rent.

In sum, rarely do I see standard language in residential leases that require the first and last month’s rent, as well as the security deposit.  The last month’s rent is an advance rent payment.  Again, according to the 1921 Peebles case, it would appear that the landlord would be able to keep the advance rent if the tenant breaches the lease prior to the last month.  However, for all practical purposes, I don’t see a housing court referee signing an immediate Writ of Recovery  in favor of the landlord when a tenant has made an advance rent payment.  One could try to make the argument with 90 year old case law, and might be technically correct, but could also be wasting time and money (with having to re-file or appeal) by using this argument.  My recommendation?  I would use the advance payment as soon as tenant is late with rent.  If tenant makes payment in the meantime, you have your advance payment back.  If the next month comes and the advance payment is gone, then bring the eviction action.

Matthew A. Engel, Esq.
The Engel Firm, PLLC
www.theengellawfirm.com
612-373-7060

Tax Court Case favors the IRS-Taxpayer did not meet real estate professional 750-hour requirement

If you are claiming to be a Real Estate Professional here is another case that points out that taxpayers needs to be documenting their time when performing real estate activities. A recent tax court case held against the taxpayer claiming that he did not qualify as a real estate professional. The Tax Court held that being “on-call” does not count towards the 750 hour requirement (Moss, 135 TC No 18).

SITUATION: The taxpayer was employed full time. The taxpayer and his wife owned a number of rental properties, including four apartments and three single-family homes. The taxpayer was directly involved in the rental properties performing rent collection, repairs/maintenance, and screening/evicting the tenants. For record keeping purposes the taxpayer kept a log detailing the dates he spent performing these activities. The taxpayer neglected to include the time spent but later was allowed to go back and prepare a time summary. The taxpayer’s total hours were 646 and did not meet the 750 hour test (as required to be a real estate professional). NOTE: Not to mention the fact that over 50% of his service must be in the real estate profession.

The taxpayer also argued that he was on-call during his employee time to handle rental issues. The Tax Court took the position that service time must be actual performance of such service. The tax court also rejected the taxpayer’s claim that his calendar reflected only 75% to 85% of his time- failure to provide proof.

CONCLUSION: The Tax Court ruled in favor the IRS and the taxpayer was subject to additional income taxes and accuracy-related penalties.

TAKE AWAY: Taxpayers claiming to be real estate professional need to keep detailed records of their time and services when working on their properties.

Greg Nelson, CPA, MBT

Olsen Thielen CPAs

www.otcpas.com/blog

Most of us are so used to buying REO properties in the last couple years, we forget all the details of buying a home with tenants in it!  I know I do.  In fact, I am so used to showing vacant houses that I recently showed up 2 hours late to a house (assuming it was vacant and not a big deal to be late), only to walk up the sidewalk and find the lights and TV are on!  Oops.

Writing offers on tenant occupied properties needs a little more attention to ensure that you get what you think you are getting when the closing is over.  If you miss something or simply assume everything will be fine, you may get a rude awakening after closing.

Here is one example:  my client put in an offer on a short sale in February and the seller accepted our offer.  During that process, we got copies of the lease and confirmed the rent amount.  We showed up at the closing today to find out that the landlord had signed a new lease with the tenant in March, dropped her rent by $300 and let her use the damage deposit to cover the March rent when she was out of work.  Now we received a much smaller amount of cash at closing, no damage deposit, and need to have a delicate conversation with the tenant that we’ll be raising the rent $300 (and she needs to pay a new damage deposit). I can see I need to update my boilerplate rental addendum.

Here are some tips on how to craft your purchase agreement when buying investment properties with tenants in them.  Most of these will take the form of an additional addendum on the purchase agreement.

• Write into the purchase agreement that the seller is not allowed to sign any new agreements with the existing tenants without written approval from the buyer. This would have fixed our problem today or at least have given us more notice than 1 hour before closing.
• In the purchase agreement addendum, write in the amount of the security deposit and language that effectively says:  “Seller will provide the buyer the security deposit in the amount of $xxxx at the closing in certified funds, regardless of the disposition of those funds between the tenant and seller, as long as tenant remains in the property”.
• Do not allow the old landlord and his bad rent collection skills to start you off in the hole.  Add language that the rents will be prorated at the time of closing between seller and buyer, again regardless of the collection status of the rents.
• Also, make sure the seller understands that you want to be notified instantly of any tenant issues at the property, such as rent collection, notice to move out, or other problems.  This can be especially important when dealing with short sales that can take months to close after you offer on the property.
• Do not allow the landlord to sign any lease extensions as it is a good idea to let them roll month to month so you can see how the tenant perform with everything prior to signing a new lease.  Worst case, if you don’t like them, give them the 60 days notice and move them out.

Buying an investment property that has tenants in it takes some additional due diligence and purchase agreement language to insure that you get what you think you are getting.

I got an email from another member of my team today that was asking for some suggestions on how his customer should handle a tenant issue.  Here is his opening email:

I have a client that is very green in the rental business. He signed a lease with a tenant for 6 months.  The tenant moved in but hasn’t paid him a dime.  No month in advance, deposit, rent etc.  What can be done to get this person out?

Ouch!  Now, I suspect that 90% of new landlords have made the mistake of not getting a security deposit prior to move in, at least once in their career.  In my experience (and I have made this mistake before), you will get that deposit only about 10% of the time.  Once they move in, you have zero leverage to get that deposit.  That tenant has no fear of you actually doing anything to them.  In fact, you can’t!  No eviction in the world is going to work to get that deposit paid.

When the tenant signs the lease, you should get the damage deposit.  And before they move in, you should get the first month’s rent.  Worst case, if the time is short, get all of it prior to move in.  If the time is long between lease signing and move in, always get a deposit as the tenant can simply walk away from the lease.  While you could try to sue them for lost rent, good luck.  Actually, you could get into a wierd situation where legally you need to evict them to break the lease even if they never lived there.  Worst case, hold the keys until they give you the security deposit and first month’s rent.  This is the last leverage you have.

Another mistake that I am sure happens, but I made only once in my earlier landlord years was to accept a personal check for the deposit and/or first month’s rent.  I am sure you can guess what happens next; the check bounces.  Now you have a tenant living in your investment property that has not paid anything to be there.  Much like the guy above.  If you have several weeks prior to move-in, you have time for a personal check to clear.  Also, if the check is drawn on a local bank, drive it over there and have it cashed immediately so you get the funds directly instead of depositing in your bank, they send it to the tenant’s bank and then it gets returned 14 days later NSF.

A slight twist on this mistake is when you are dealing with a tenant that get’s a rental subsidy like Section 8.  The tenant talks the talk like they know exactly how it all works, saying they have talked to this person or that agency and you are going to get your money.  Never take the tenant’s word for it.  Call the agency or have the tenant provide written proof of the subsidy.  Just because they say they are getting emergency assistance to pay the security deposit, doesn’t mean they qualify for it.

Taking some precautions and holding the keys ransom for the money is the best option.  By they way, I told this agent to file the eviction immediately (since they also owed the first month’s rent).

Despite being a landlord for over 6 years, I swear I learn something new in this business every month.  Have you ever leased your property to a tenant (Section 8 or not) for less than you were really trying to get?  Most of us have.  Maybe it is a slow rental time of the year, maybe you just haven’t had many calls on the apartment, maybe it is 2 weeks before the first of the month and you just want to get the place filled.  I bet every landlord has done this at one point.

So then, how do you get the rent back up to where you want it to be without upsetting anyone?  With non-Section 8 tenants, I tread lightly.  I would rather sacrifice $50 per month than have them decide to start looking and move out.  Each turnover costs me $1000-$2000 in painting and property repairs, even when they leave the place perfect.  Plus, that is assuming that I will NOT have any vacancy time.  In my book, that $600 that I am losing per year is cheaper than a turnover.

A friend of mine that does property management for about 250 units (60% of them get some rental subsidy like Section 8), told me something I never knew.  You can raise the rent on a Section 8 tenant dramatically in one year or every year and Section 8 will approve it.  This is even if it goes over the maximum rent amount for that unit. Me and another landlord just sat there with out mouths open, about to cry over all the money we had left on the table over the years!

Here is an example of how it works:

• You have a duplex with two 3 bedroom units.  Both units are identical.
• You typically rent each unit for $1200 per month.
• The previous tenant moves out in December and you are having a tough time finding a tenant.
• A prospective tenant calls you about the apartment and says they have a Section 8 voucher that will only pay $1095.
• In a pinch and desperate you decide to take them, despite getting $105 less per month that you normally get (after running the typical tenant screening process).
• You sign a lease at $1095.
• At month 10 (60 days before the expiration of the lease), you contact the tenant to see if they want to stay.
• If so, you draw up a new lease for $1200 and have them sign it.
• You submit the new leaseand documentation of the rent for at least three other comparable 3 bedroom units in duplexes with the same amenities, in the same neighborhood, to justify your rent increase.
  • The other comps must be NON-Section 8 tenants.  You are trying to show what the market rent is for that property.
  • One small wrinkle is getting comps.  You can definitely use the other unit in this duplex in this example, but then you may need to figure out a way to provide proof of other units in the immediate area renting for the same amount.  Hopefully you either have other buildings nearby or maybe you can ask a neighbor landlord to give you a copy of his/her leases for this.
• There is no guarantee that Section 8 will approve this, but if you have a decent case with good comps, my friend said he has raised the rent $200 one year to get the property to the correct amount.

One question that got asked was, why would the tenant agree to a large increase.  The answer is that they may not feel the increase as Section 8 may simply pay the difference.  While you can’t guarantee this, it is worth mentioning.  Alternatively, I do know that Section 8 will mostly ignore smaller yearly increases of $25-50.  These just fly under the radar.

So…..Watch for your lease renewals on your Section 8 properties and bring your rent up to market standards.

I am sure with that headline and what I am about to say will get me some hate e-mail, but I just tell like I see it (even if it is not 100% politically correct or polite). So I stopped by one of my units in Northeast Minneapolis this weekend to find that the tenant moved out in the middle of the night, owing me May rent.  Nice!  On top of that they left a couple pieces of furniture in the house, 2 beds in the yard, and no cleaning (surprise).  How did this happen to me again?

As I was having a little pity party in my unit, I had an epiphany.  This tenant had some telltale signs that I should have picked up on when I showed her the unit the first time.  While none of these are 100% reliable and I am sure there are many exceptions, and while I am sure I will get hate mail for saying some of these things, just chalk this up to my gut feeling and experience over the years.  Here are some correlations that I have noticed with bad tenants:

• One of my big pet peeves is seeing window screens pushed out or damaged on rental properties.  I don’t think I have ever wrecked a screen at my house.  I see tenants push them out all the time.  In fact I had a tenant last summer simply push the window air conditioner through the screen instead of removing it!  Bad tenants seem to treat the screens on the house like the treat the rest of the house.  They abuse it.  By stopping by and checking out their current living situation, you should be able to notice this.
• When you are running the tenant’s application, if there are any credit issues, collection items, or evictions, that is going to continue to be a problem.  Now I understand if you got laid off, went through a divorce, got sick and had a period in your life well that is explainable, but most bad tenants just seem to have no regard for payment of bills.  Just like any bad habit, once they get used to doing it often, it gets easy.

While I could go on and on, these are some quick thoughts that come to mind (and help me vent my frustrations).