Are you buying a fix-and-flip home in New Jersey?
Purchasing a recently rehabilitated house has the advantages of beautiful and new upgrades – but there are legal considerations to pay attention to. Learn more in the video or transcript below!
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Good morning, this is Earl White. This week’s video is about five legal considerations when buying a fix and flip in New Jersey. We’re going to go over what are five key considerations to be aware of and how to approach them from a contract and deal perspective as you’re working on a fix and flip in New Jersey. If you find this video helpful, please give it a share with anyone that you think it would be helpful for to review as well.
Okay, so first is to be careful with added assessments. An added assessment, essentially, when a party, particularly a seller, makes improvements at a property. So maybe they added particularly anything permitted, so any notable improvements to the property that are done before the closing when the new buyer takes ownership that have not yet been factored into the property value by the city, which is very common. Obviously if you’ve been doing renovations for the last two or three months, it is not yet going to be factored in to the property value. So at the end of the year most likely, the city is then going to look back retroactively to probably before the closing and say the property value had been increased before the closing, and therefore taxes are now owed even though those periods of payment have passed for that period from before the closing, and now the new owner has to pay taxes.
The issue there is that the new owner didn’t own the property for the period those taxes are due. So if it’s your buyer client, they’re going to call, maybe call me, call realtors, call whoever, being concerned or frustrated that, “Hey, I got this tax bill for a period I don’t own it. Why am I going to have to pay these taxes?” Because obviously that’ll become a lien on the property. So how do you mitigate the risk with that? During attorney review, and I very rarely see this added in on some percentage, but I always make sure to add it in, you want to add a provision that says in the event there is this added assessment after the closing, the seller will then pay the buyer back for the taxes during their period of ownership.
So I had a client call me last week. It was 3 or $4,000 from before the closing, but we had the attorney review provision in there, so the seller pointed it out. The seller came back and said, “Look, I agreed to it and paid the money to my client.” If that provision had not been there, then the seller probably… And they may have done it out of the goodness of their heart, but they would’ve been no legal hook to make them pay it.
Another consideration is bulk sales. What bulk sales is is a New Jersey law that says that after a buyer closes on a property in certain circumstances, they would then inherit any tax liabilities the seller had on the property. Now this is applicable if you’re buying from an LLC. We’re talking about fixing flips here, right? So fix and flips, oftentimes it’s a house flipper, they’re an llc, they’re a corporation of some kind, and bulk sales will apply. So obviously what you do as the attorney is you submit a bulk sales filing and basically you submit this filing to the state of New Jersey and then within 10 business days, the state of New Jersey comes back and says there’s no tax liabilities owed or there are tax liabilities owed, but either way, once that bulk sales is submitted, the buyer no longer has this liability to take it on just because they made the submission.
Now, a couple of red flags here that you pay attention to, particularly in attorney review to protect the buyer, is one, a lot of times the seller’s attorney will say… So bulk sales, it applies to if there’s an LLC selling the property. There’s an exception where it would not apply if that LLC is acting in their ordinary course of business. So the idea being that the state of New Jersey doesn’t want to get bulk sales filings every time an… If an LLC is doing 50, 60 deals a year, they don’t want to keep getting filings. So there’s an exception for this, for an LLC acting in the regular course of business.
But I could tell you a lot of times seller’s attorneys will say, they’ll look at just because it’s owned by an LLC, “Oh, it’s a regular course of business.” And people just go along with this. They just go along with it. But here’s the problem, is that just because it’s owned by an LLC doesn’t mean that that’s the regular course of business. One important distinction to draw I think here is that it’s not about the principle of the LLC, that if it’s their personal regular course of business. It’s about the LLC. So if the LLC itself is newly formed or if the LLC itself is one of those LLCs with the property address in it, like in the name, this LLC does not have a regular course on business history where you would get the exception for this.
So now the reason it becomes particularly relevant is you need the seller to… So to submit this filing that will absolve the buyer of liability, you need the seller to give the federal tax ID number and other business address and other information to submit the filing. And a lot of times the seller LLCs they’re like, “Oh, I don’t need to do this, regular course of business. I don’t want to comply.” Because they don’t want to take the risk that the submission to the state is going to find a new tax liability for them and then they have to deal with that before the closing.
So what you do here is or what I always do is that in the attorney review rider, and it does come up sometimes, but a lot of attorneys won’t do this, you put a provision in there requiring the seller to comply with bulk sales. And a lot of times, even though I have that in there, they agree to it and I still go collect the information after the closing and they’re like, “Oh, we’re not doing that. We’re not going to give it to you.” I’m like, “Oh no, you are going to give it to us because it’s in the attorney review rider, so you are going to give it to us.” And then usually they’ll back down and say, “Okay, we’ll give it to you now.” But it’s important to have it covered in your attorney review because I have seen this blow up for colleagues after the closing where the other side’s like, “We’re not complying or giving you tax ID information because it’s regular course of business.” So get it in the attorney review rider that they’re going to have to comply with it.
Now obviously you don’t need to do this if it’s Lennar, Pulte, if you’re buying in a development. If it’s one of those type of companies, it’s a relocation company, then obviously it’s a regular course of business. You don’t need to create a problem about bulk sales. But if it’s just this random LLC and there’s no history and if it’s got the name of the house in it, the name of the address, obviously this is a single purpose entity that essentially is liquidating. This is not regular course. This is liquidation of their only asset. So that’s exactly what bulk sales is intended to apply to, liquidation. And so yeah, you want to make sure you get that covered in attorney review.
Buying fix and flip, like we mentioned, often owned by an llc. And so when LLCs also acquire these properties and fix and flip them, they often were distressed properties prior, and they were in distress. And when you have these history of distressed properties, there tends to be ownership and title problems, particularly because A, sometimes they became distressed because maybe it was a probate or a foreclosure or a mortgage foreclosure, a tax foreclosure. Maybe it became distressed ’cause it was just getting passed around from family member from family member. So the point I want to make here is that these fix and flips were often distressed properties. Distressed properties were often had title issues relating to the reason they became so distressed, ownership transfers again.
So whatever you can do there to mitigate the risk is to really have a proactive attorney that’s going to order a title search right away, have a proactive title company that’s going to get you a title search pretty quick back because then if these title issues come up, at least you can start getting them resolved in advance of the closing so you don’t have any long delays or if the deal’s going to fall through because these title issues can’t be resolved, then at least that will happen sooner rather than later with a proactive attorney and title company.
Next thing I want to point out, fix and flips. So just because it’s looks beautiful doesn’t mean that all the proper legal channels have been followed in particularly relating to either having open permits or having failed to obtain permits for work that was conducted. I’ve seen a lot of times where even if you ask the seller up front, “Hey, were there any open permits?” They’ll be like, “Oh no, no open permits. No open permits.” But then we get the deal moving and then we find out about there’s a ton of open permits or there were some improvements that were made that should have had permits but didn’t. So what you can do to mitigate the risk on that one is just when you get out of attorney review, have the attorney or someone to submit an open public records act request to get the permit history. And this way you can have someone take care of these permitting issues early in the deal so you don’t have a delay down the road.
And this comes legally or to the buyer very important. If the city does not have some kind of CO requirement… If no one from the city is going to go prior to the closing to check if there’s work without permits or check the city record, which in some cities, they don’t have any requirements like that, it’s really going to come down to the attorney working on the deal to identify this problem or the realtor working on the deal to identify the problem, or I guess the buyer could do it. Most buyers, they might not be aware of all these things. So it’s going to come down to the attorneys working on it to [inaudible 00:09:25] resolve it. And to that extent, you also have to make sure the attorney review rider covers it. Inspection contingency is not enough. Inspection contingency says if there’s defects at the property, then the buyer can raise those and the seller has to either remediate them or the buyer can walk away. That’s standard.
What’s not always included and not always standard is what’s going to happen when everything is done, all the work looks beautiful, all the work was done properly from a physical defect perspective, but all the legal channels and the permitting weren’t obtained. And so that can get a little bit dicey, and there could be some disagreements. So what you want to have is an attorney review provision that tackles open permits, open code violations, or also work that doesn’t have any open issues, but just they didn’t get the proper channels ’cause it’s not clearly an inspection issue. So you need that covered separately.
Next thing I want to point out is signing authority. If you’re buying a fix and flip, very good chance you’re buying from an LLC, as we mentioned. So with the LLCs, sometimes the properties will change hands for perfectly legitimate reasons, but you want to make sure whoever signed the contract had authority to do so, and sometimes you’ll learn that that’s not the case. Someone signed off and they may not have had authority to do it. So normally what I would do is an attorney review, add a provision to the rider, something along the lines of… You don’t want to hold up attorney review for this because it’s a low probability event, but something like, “Within seven days of concluding attorney review, the seller to provide documentation showing that they were authorized signers on behalf of the seller and can’t complete the sale.” And that usually means getting the operating agreement from the company, the LLC, and then also a certificate of good standing and a certificate of registration.
If there is no operating agreement that’s been signed, then really it’s just comes down to having the certificate of registration, showing who the members are, and then making sure all those members signed the contract so you don’t have any disputes down the road about whether it’s a legally binding contract. And that all gets resolved early in the deal rather than having a problem after all the work has been done on the deal before the closing.
Okay guys, like I said, if this video was helpful, feel free to share it or give it a like. Thank you.
This guide applies to buying a fix-and-flip or rehabilitated home in Newark, Jersey City, Hoboken, Paterson, Elizabeth, Union City, West New York, Bayonne, East Orange, West Orange, North Bergen, Clifton, Bloomfield, New Brunswick, Atlantic City, and across Bergen County, Essex County, Hudson Couny, Union County, Morris County, Somerset County, Atlantic County, Monmouth County, Middlesex County, Ocean County, and Passaic County.
Call us at 201-389-8275 or visit the Contact Us page for assistance with any real estate sales. Note: The information provided in this article is for informational purposes only and does not constitute legal advice. Readers should contact an attorney for advice on any particular legal matter.