Traditionally, real estate that is transferred by sale begins several months before the closing date. Negotiations begin, a written purchase agreement is drafted (containing: a property description, the names of seller and buyer, the price, and other important terms), money is transferred into escrow, and inspections (environmental and structural) are ordered.

Although, real estate sales through Land Contracts should be similar to traditional sales, they often take place without legal counsel whereby neither party is protected and without much organization. An agreement is drafted to transfer title if the buyer makes x monthly payments in y amount with z interest until the sale price paid (a final balloon payment is not unusual).

Under both sale types, traditional and land contract, marketable title is implied in every transfer at closing. Marketable title does not mean perfect, rather it means free from unreasonable risk of litigation. Unmarketable title may mean: a defect in the chain of title such as a variation in the legal description or defect in the deed. Encumbrances such as mortgages and liens may be satisfied at closing. Unwaived easements, restrictive covenants, and significant encroachments may render title unmarketable.

Traditional Land Sale: Title must be marketable on closing, and unless an agreement states otherwise, time is not of the essence.

Land Contracts: Title must be marketable when delivery of title occurs (final payment).

If a buyer determines that title is defective (unmarketable), the buyer must notify and allow the seller to cure the defects. Generally, if the seller does not cure unmarketable title the buyer can sue for damages, unless the contract says otherwise.

UNIFORM PARTNERSHIPS
Michigan, like other states, has adopted a version of the Uniform Partnership Act (UPA) MCL 449.1 et seq., as well as the Uniform Limited Partnership Act (ULPA) MCL 449.1101 et seq. The law of contracts and agency serves as a base for partnership law.

JOINT VENTURES
A joint venture is a partnership, although courts often distinguish the two, legally the result is often identical.

Partnerships are defined as an association of two or more persons to carry on as co-owners in a business for profit. Anyone may be a partner, so long as they are capable of signing a contract; however, no written contract is inherently necessary to form a partnership. And unlike a corporation, the debts of the partnership, are the debts of the individual partners. Partnerships may acquire land and partnerships may be sued.

General Property Interest Characteristics
Ownership in any specific parcel of real property held by a partnership is characterized as a tenant in partnership. Unlike tenants in common, joint tenants, or owner fee simple absolute, these ownership interests have unusual “outcomes on event“. Each partner has an equal right with co-partners to possess property, so long as it is used for partnership purposes. The right of one partner to possess property is not assignable to non-partners; likewise one partner may not mortgage the property interest. On the death of a partner, the ownership interest transfers to the surviving partners; therefore, there is no right to a dowery interest in partnership property.

Liability
When deciding to form a partnership, a frequent question around the liability of the partnership in relation to the individual is brought up. In straight partnerships, the partners are liable for the actions of the partnership, and many times the actions of another partner. The partnership, through the partners, must indemnify other partners for payments and personal liabilities incurred in the course of business; similarly, if one partner pays a debt of the partnership, the other partners are compelled to contribute.

Civil Liability (torts and contracts): In general, partners are liable for contracts made or torts committed by a partner or employee during business operations.

Michigan LARA allows the filing of CSCL/CD-401 to file a Limited Partnership (LP); and, CSCL/CD-800 to file a Limited Liability Partnership (LLP). Limited Partnerships are composed of one or more general partners and one or more limited partners; whereby, the limited partners liability is limited to capital contributed, and the general partners are treated no different than any other partnership. Limited Liability Partnerships prohibit vicarious liability for torts of other partners. Limited Liability Limited Partnerships are a hybrid between limited partnerships and limited liability partnerships.

Partnership Tort Liability Conclusion
Partnerships: Partners are liable for torts jointly and severally.
Limited Liability Partnerships: Partners are generally no liable for torts of other partners.
Limited Partnerships: Limited Partners are not liable for torts of other partners.

Liability is one of the biggest reasons most entities suited for partnerships, choose Limited Liability Companies (LLCs).

Earlier in the year an article was written as Part I of contracting; pointed towards businesses who rely on self-drafted contracts. For review, generally contracts are a set of promises, made orally or written, that the law allows a remedy if the promises are breached. The base law of contracting is divided between the Sale of Goods (Uniform Commercial Code Article 2) and common law (or law of the courts).

The Sale of Goods Contracts.
Sales are those contracts that transfer title of movable things, or goods. Therefore, the sale of goods do not include real estate, services, construction contracts, or other intangible things. Article 2 of the Uniform Commercial Code (UCC A2) governs remedies, breaches, warranties, and other aspects of sales involving goods.

The Non-Good Contracts.
Common law governs contracts of everything other than the sale of goods.

Hybrid Contracts.
Where there are services involving goods, such as a mechanic working on a car, the courts will decide which law to apply, though the assistance of several rules used to determine which law to apply (common law or UCC A2). Often times the law applied won’t change the outcome and no decision of law must be made.

The Statute of Frauds.
Most (actual) contracts that are oral will be enforceable. However, there are some contracts that must be written, due to its’ nature. The writing requirement of the statute of frauds does not in actuality require that the contract is written, merely that the material terms are written and signed.  The following agreements must all be evidenced by a writing:

• An executor’s promise to personally pay the debts of an estate.
• Suretyship or a promise to pay the debt of another.
• A promise in consideration of Marriage.
• A promise creating an interest in land.
• An agreement that by its terms cannot be performed within one year.
• The sale of goods in Michigan for $1000 or more.

When contracting in Michigan be certain that you follow the rules of contracting precisely, failure to do so often results in high cost to defend, resolve, or remedy.

An article circulating amongst real estate syndicates, investor groups, and developers purports that a Irrevocable Trust and that not a Limited Liability Company (LLC) is the ideal legal entity type to hold real estate investments. For the quick answer, generally LLCs are the ideal entity type to hold real estate investments; the law dictates that no two parcels are identical, and so it follows that every real estate investment is different, therefore some real estate investments are suited for Irrevocable Trusts. There are many investment entities that are suitable for investment including Limited Partnerships, Limited Liability Companies, and Corporations.

Real Estate Investment Trust (REIT) (semi-technical reduced for complexity, skim if necessary)
Some Irrevocable Trusts are REITs but not all REITs are trusts (irrevocable or otherwise). Internal Revenue Code (IRC) section 856 defines REITs as a “corporation, trust, or association” which is:

• managed by trustees or directors;
• beneficial ownership in the REIT is transferrable;
• would be taxable as a domestic corporation if not for this section (26 USC § 856);
• is not: (a) a financial institution described in (26 USC § 582(c)(2)): a bank or foreign ‘bank’; cooperative and mutual banks; licensed § 301 small business investment company (SBICs) (see Small Business Investment Act of 1958 for private equity and venture capital LLCs or LPs as amended post 2005); Business Development Corporation (see below bold titled); or (b) insurance company (see 26 USC Chapter 1, Subchapter L).
• ownership is held by 100 or more persons;
• (through reasonable diligence) is assumed to be not closely held under 26 USC § 542 meaning greater than 50% of ownership is held by 5 or less individuals; and,
• meets all 26 USC § 856(c) limitations, REITs must comply with all of the following:
  1. REIT election has not been terminated or revoked (see 26 USC § 856(g));
  2. (January 1, 1980 onward) 95% of its gross income is derived from: dividends, interest (see (G)(i)-(ii)), rents, sale of securities and real property (excluding 26 USC 1221(a)(1)), tax refunds, foreclosure income and gains, allowable transactions under 26 USC § 857(b)(6) (prohibited transactions), first year mineral royalties;
  3. at least 75% of its income is derived from: rents, interest (from real property mortgage) and (see (G)(i)-(ii)), sale of property (excluding 26 USC 1221(a)(1)), dividends, tax refunds, foreclosure income and gains, allowable transactions under 26 USC § 857(b)(6) (prohibited transactions), qualified temporary investment income; and,
  4. at least 75% of assets is in real estate, cash, account receivables, government securities; and not more than 25% is in other securities OR taxable REIT subsidiaries, EXCEPT no more than 5% of its total asset securities in any one issuer, the REIT does not hold more than 10% in any one issuer, and the REIT does not hold more than 10% of outstanding value of one issuer…

Business Development Corporation is a corporation created pursuant to State law “…for purposes of promoting, maintaining, and assisting the economy and industry within…” the “…State by making loans to be used in trades and businesses which would generally not be made by banks within…” the “State in the ordinary course of their business (except on the basis of a partial participation), and which is operated primarily for such purposes” (26 USC § 582(c)(2)(B)).

Even by skimming the above-summarized statute it should be obvious REIT should not be confused with a form of Trust or Corporation (that defeats one misconception).

Business Entities
A business entity is first (a) separate from an individual (legal personality), second (b) suited for business activity, third (c) it has more favorable taxation than several individuals, fourth (d) it has favorable liability protection for the torts of the entity, and five (e) ownership is generally transferable to another person.

Trust Entities
A trust entity is first (a) fiduciary relationship (duty to manage, invest, safeguard, and administer trust assets and income) in which the trustee(s) hold legal title for the benefit of designated beneficiaries who hold equitable title, second (b) may have favorable tax treatment compared with probate assets (think will vs. trust), third (c) is centered around a particular asset or assets owned at one time by the settlor (person who sets up the trust sometimes known as the grantor).

Why a trust may not be suitable for doing business.

• It is assumed that if the sole-Trustees are also listed as sole-beneficiaries, then legal and equitable title merge and the trust disappears (no trust exists) MCL 700.7402(1)(e). Someone (beneficiary) must exist to hold the trustee accountable to carry out the terms of the trust, and the same person cannot owe those duties to him or herself. However, the settlor can be the only beneficiary as long as the settlor is also not the only trustee.
• Trustees may only leave the administration of the trust by (i) providing 28 days notice, or (ii) through court approval (MCL 700.7705).
• Trustees may be removed if there is a serious breach of trust, lack of cooperation amongst co-trustees, persistent failure to administer the trust effectively, or substantial change of circumstances where removal of the trustee is in the best interest of all beneficiaries (MCL 700.7706). It is important to note there is no provision for payment to a removed trustee; in business if an owner is ejected he or she must receive a return on their interest in the business.
• Trustees are disallowed from following the purpose of the trust. The trust will fail if the purpose is to evade settlor’s creditors (see MCL 700.7404 for more information on trust purpose).
• An irrevocable trust without a spendthrift provision will allow creditors to reach the beneficiaries interest through garnishment or attachment (effectively defeating the only advantage a trust might have over a standard business entity). (see MCL 700.7502 for more on spendthrift and Fornell v. Fornell Equipment, Inc., 390 Mich. 540 (1973)). However, once the distribution has been made, the money is no longer protected MCL 700.7502(3) (procedurally creditors must move FAST after disbursement for obvious reasons).
• Property owners are not allowed to transfer assets (via spendthrift trust) for the property owner’s benefit to avoid creditors’ reach. Any interest retained by the settlor in any asset may be reached by the creditor in full. (see MCL 700.7506(1)(c) for more on settlor-beneficiary interests).
• Michigan disallows discretionary spendthrift trusts, whereby the trustee has complete discretion to disburse trust income to a class of beneficiaries (used to evade creditors). (see MCL 700.7505 for nuance in language of ‘pure discretion’).
• If more than 1 person or entity contributed to the trust, they are all settlors (MCL 700.7506(2)) and all retained interests may be reached.
• Additionally since settlors, beneficiaries, and trustees are typically individuals, unique situations arise in Michigan around dowery, divorce, and other familial legal actions.

Under most circumstances, the best method of administering and planning a real estate investment (or any other type of investment) is to incorporate under a business entity statute. The second step is to then place your personal assets into a trust revocable or irrevocable depending upon your needs. Speak with your trusted counselor for more information, it is important to explore new ideas and convey your intentions accurately to your lawyer.

Think about Real Estate.
Anyone who is selling a business or investment property should consider the benefits of a 1031 Exchange also known as a like-kind exchange. Internal Revenue Code (IRC) Section 1031 allows an investor who sells a property and reinvests the proceeds in a new property to defer all capital gain taxes. IRC Section 1031(a)(1) states:

“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held for productive use in a trade or business or for investment.”

To be eligible for a 1031 exchange the buyer basically must:
– Purchase property that will be held for investment or used in a trade or business;
– Purchase property of equal or greater value; and,
– Obtain the same or greater debt on the new property.

The Internal Revenue Service (IRS) does mandate that an investor:

(1) identify the new property within 45 days of the sale of the original property and close within 180 days;
(2) use a qualified intermediary (QI) to hold the proceeds of the original sale (a QI is a company that is in the full-time business of facilitating IRC Section 1031 Exchanges and is further defined under IRC Section 1031(k)-1(g)(4)); and,
(3) reinvest all of the equity from the sold property into the new property.

For example: if an investor buys an income property for $250,000 and later sells the property for $350,000, the investor has made $100,000 that would be taxed at the capital gains rate. If the investor reinvests the $350,000 in another income property this could qualify as a 1031 exchange and allow the payment of the taxes to be deferred.

In many instances 1031 exchanges are very useful in deferring an investor’s tax liability. The exchange should be contemplated before the sale of the initial property and structured to best benefit each investors unique concern. It is wise to consult an experienced attorney if you are considering a 1031 exchange.