Each year, homeowners in subdivisions and condominiums throughout Indiana complain to their state legislators regarding real and perceived problems with their neighborhood associations.  Those elected officials respond each year by introducing a variety of legislation designed to solve the problems of their constituents.  This year was no different.  There were a number of legislative initiatives, some potentially catastrophic, that were introduced into the 2011 Session of the Indiana General Assembly. Fortunately only a few became law.  However, those bills will have an impact on the operation of homeowners associations in Indiana. This article will discuss the 2011 initiatives that became law.

House Enrolled Act Bill 1058

The Indiana Attorney General is granted certain authority in cases where non-profit corporations do not act within their guidelines or where government officials misspend public funds.  Current law exempts homeowners associations from this regulation.

House Enrolled Act 1058 allows the Indiana Attorney General to bring a legal action against an HOA board of directors or an individual director, if the Attorney General finds that :

(1) the association’s funds have been knowingly or intentionally misappropriated or diverted by a board member; or

(2) a board member has knowingly or intentionally used the board member’s position on the board to commit fraud or a criminal act against the association or the association’s members.

This legislation will not allow the Attorney General to become involved in assessment collection actions or in disputes regarding covenant enforcement or maintenance responsibilities.  However, in cases where one or more of the board members knowingly or intentionally misappropriate or divert funds or commit fraud or criminal acts, the Attorney General may step in.

Legislative committees heard testimony about instances where board members paid themselves exorbitant sums to perform work in the neighborhood; where board members appropriated significant sums of money for projects that benefited only themselves; and in one case where a board loaned significant sums of association money to a friend of the board members. These are the types of conduct where the Attorney General may become involved.

Under the Act, a Court could enjoin the improper conduct or could order a board member to make restitution; to be removed from the board and/or to reimburse the State for the reasonable costs of the attorney general’s investigation and prosecution of the violation.

This Act will not impact board members acting within the scope of the covenants and in the best interests of the neighborhood.  However, in those cases where the conduct of a board or a board member is clearly outside the scope of reasonable behavior, the Attorney General may become involved.

House Enrolled Act 1541

This act prohibits “transfer fee covenants”.  The use of Transfer Fee Covenants has not yet reached Indiana, but has become prevalent in some western states.  In those states, finance companies will enter agreements with developers where the finance company pays an up front  lump sum to the developer in exchange for a “transfer fee covenant” that will impose a transfer fee, usually in the 1% range, every time a residence in the neighborhood is sold, for the next 100 years. The finance company assumes it will make a profit over time on each sale.  The fee provides no benefit to the neighborhood or the Association.  Several states, now including Indiana, have outlawed this practice.

The Act has been written so that it does not prohibit standard charges by homeowners associations or their management companies, for processing the paperwork for transfers of homes within the subdivision.

Senate Enrolled Act 155

This legislation initially dealt with tax warrants, but was amended to impact the collection of homeowner’s association assessment liens.

Under current Indiana law, a homeowner’s association can file a lien against a property if the owner fails to pay his/her assessments.  The current law provides that the association cannot foreclose that lien until at least one year after it is recorded.  This Act shortens the time period from one year to ninety days.  The waiting period is waived if someone else files a foreclosure action against the property or if the property owner issues a written demand that the association bring suit sooner.  This legislation will help homeowners associations in collection cases. .  .

The catastrophe that did not pass.

Senate Bill 144 was introduced to address the problem of children and drivers who drown in neighborhood retention ponds.

Many neighborhoods in Indiana have retention ponds, that were mandated by government authorities to deal with drainage issues.  Unfortunately, there have been a number of instances where vehicles have been driven into these ponds and/or where children have wandered into the ponds causing injuries and death.  Senate Bill 144 would have allowed local government entities to construct whatever types of barriers they deemed appropriate to prevent vehicles from driving into the ponds and to “child proof:” the ponds.  No input from the residents in the neighborhood was required.  The bill also provided that when the construction was completed, the government authority could then assess some or all of the residents in the neighborhood, at the sole discretion of the government authority, to pay the costs of work.

While the cause is noble, the implementation of the bill could have been catastrophic. The ponds were installed by developers at the request of and with the approval of local governing authorities. The homeowners were never part of the equation. The bill however, put the entire economic burden on the homeowners.

The issue should be addressed, but the method and the cost of addressing the issue needs significant further study.  Look for future legislation.

The Indiana General Assembly has passed legislation affecting the way homeowners associations conduct their business in each of the last several sessions.  You should expect more of the same in future sessions.

The construction job is complete.  Your invoice has been submitted to the customer.  However, several weeks have passed since you submitted the invoice and you have not been paid.  On your last day at the job site, the architect (or foreman, general contractor, building manager, homeowner, etc.) told you that he was delighted with your work, asked you for business cards to submit to colleagues and friends, and promised that you would be paid “but it might take a few extra days.” When you were out with your spouse during the weekend, you were sure you saw your customer at the ballgame (or grocery, trade show, department store, movies, etc.) but he put his head down and walked the opposite direction.  That is when you realized that you have a problem – you are not going to get paid.  Of course, your fears are confirmed when your phone calls or emails to the customer go unreturned or are returned at times when you are sure not to be in the office.

Mechanic’s liens can be an effective way to lower your risk when it comes to bill collection.  However, Mechanic’s Liens are not foolproof. Indiana’s Mechanic’s Lien laws are technical.  If you make a mistake with the lien requirements, that lien could be invalid.  Also, you may have been talked out of filing your lien by a general contractor – “I’m not getting paid either, buddy.  Don’t make waves because we’re all in this together.  The next draw is due any day now.”  Depending on the project, you only have a limited time to file your mechanic’s lien.  When that time expires, so do your lien rights.  Also, ‘no-lien’ contracts are common. By agreement, your mechanic’s lien rights are waived; or more likely, the ‘no-lien’ status of the work was offered as a ‘take it or leave it’ option as part of the request-for-bid stage.   Regardless, you still have an unpaid invoice and possibly laborers and material providers that want to be paid.  A mechanic’s lien is certainly not the only mechanism to getting an invoice paid or to lowering your collection risks.  Failing to timely file a mechanic’s lien, being party to a no-lien contract, or filing a flawed lien that is found to be unenforceable is not the end – you have other options.

The place to begin with collection problems is at the very start of the relationship by making sure you are using a good written contract. A good written contract, when used appropriately, can head off problems with your customer before they begin.  Ambiguity between the parties’ understanding of the contracted work, especially when working with homeowners, is a major source of dissatisfaction with a finished job and a customer’s reluctance to pay an invoice.  With homeowners, the contract negotiation stage will be your first chance to begin the process of educating them about construction standards and practices that you may take for granted as understood when working for a general contractor or colleague in the trades.  Use this chance to begin setting fair and reasonable expectations.  Material samples and photos of previous work done help in this regard.  By defining clearly the terms agreed upon, including a detailed scope of work, estimated time of completion, change order procedures, job finish specifications, type, brand and quantities of materials to be used and payment terms, your reluctant customer will less likely be disappointed with the end product.  Make sure to give your customer a few days to review the contract before you begin work.  Courts are less likely to enforce a contract in your favor if it was signed without first giving your customer the chance to read carefully the document and possibly get third-party review.  While not a collection issue, have a qualified attorney review your contracts to make sure they comply with the Indiana Home Improvement Contract and Warranty Statutes.

During negotiation of the contract, you may lower your collection risk by requiring the customer to pay a deposit, pay draws, or pay material suppliers directly. Using one or a combination of all these options will not protect you completely if a customer defaults, but it will cushion your fall if a customer refuses to pay.  Paying a deposit at the start of the job provides funds so you do not have to pay out of your own pocket to start the project.  Should the job be several weeks in length, requiring periodic payment of draws further reduces your risk and shortens the time between job completion and your final invoice.  While a deposit and periodic draw arrangement would be ideal, some jobs can be completed before a draw would be due.  In those cases, consider proposing payment of a deposit and direct payments by the customer to material suppliers.  If you do not know your customer well, he may be reluctant to make a significant prepayment to you.  Therefore, payment to the third party material supplier may overcome the customer’s anxiety and limit your risk.  This would leave you only with labor and profit as outstanding debts.  Not an ideal situation, but certainly better than the alternative of having materials outstanding, too.

Keep this in mind when negotiating – proposing deposits, draws, or direct material payments can act as a test; you are hiring your potential customers just as much as they are hiring you.  If a customer balks at all of these payment proposals, insists you start the job as soon as possible, refuses to make any payment until the job is complete and shows little if any interest in the details of the contract, be concerned, be very concerned. This is a customer you may want to think twice about working with.

On insurance restoration jobs, an additional term you can negotiate into your contract is an assignment of insurance proceeds directly to you or joint payment drafts to you and the customer. Insurance claim settlement amounts often will be calculated based on your and your competitors’ quotes after being reviewed by an adjustor or in conjunction with an inspection by an adjustor.  To accomplish this, you will, of course, need an agreement with your customer.  You may make this type of payment arrangement a requirement of your providing a quote to do the work.  Make sure that the assignment or joint payment agreement is in writing.  An attorney can prepare a simple assignment of insurance proceeds or joint payments agreement for you to use as an attachment to your written contract.

Keep in mind, if you and your customer agree to a direct assignment of insurance proceeds, the insurance company’s payment will be less the customer’s deductible.  Make sure your customer understands that he may have to make an additional payment to cover the deductible.  Consider getting that amount in the form of a deposit directly from the customer before work starts.  If you and your customer agree to the joint payment of drafts, make sure that your customer understands that he cannot negotiate that insurance payment with his bank without your consent.  The same goes for the contractor; the customer’s signature will be needed to negotiate the insurance check with your bank.  While this is a less preferred method than simply having the insurance proceeds directly assigned to you, it creates a type of escrow situation where both parties have to be in agreement before the insurance proceeds can be released.

If you file a lien but it has a technical flaw that makes it unenforceable or if the filing deadline passes before you could file the lien, all is not lost.  You may want to consider litigation for a breach of contract action or “unjust enrichment.” The difference between a breach of contract action and unjust enrichment is very simple:  Breach of contract actions are based on written contracts.  Unjust enrichment claims can be raised when materials or labor were provided to a customer without a written contract and the parties dispute whether or not they had an understanding or agreement. Again, using a good written contract has more benefits than just those mentioned above.  You should look at every contract you sign with the perspective of “what if I had to go to Court to enforce this document.”  If you have a customer who refuses to pay you and your lien period has expired or you entered into a no-lien contract, then you will likely have to walk away from the debt or go to Court to have the contract enforced.

If you made the mistake of doing a project without a written contract and your customer refuses to acknowledge that you had an understanding to do the work, then you also may be able to seek recovery from a Court for unjust enrichment.  The legal theory of unjust enrichment is that it would unfair to allow one party to be benefited by the labor and materials of another at the expense of the party who did the work.   It would be careless to think that unjust enrichment makes using a good written contract unnecessary.  However, for those instances where a contract was not used or, for whatever reason, was not valid, unjust enrichment provides a remedy for when a customer decides not to pay.

Of all these methods reviewed, including mechanic’s liens, the best way to avoid an invoice dispute is to deliver the job on time with a high level of workmanship, keep communication open, and never miss an opportunity to educate your client about your products and services. While unfortunate, there is a very small portion of the population who are professional deadbeats.  It is best to avoid doing business with them.  However, many invoice disputes are related to misunderstandings that could have been avoided.  Reinforce reasonable expectations in your client and refer to the contract if there are questions about your responsibilities.  Make sure to always use written change orders for additional work. If you implement these methods you will reduce invoice disputes, increase your bottom line profits, and raise your reputation in the building community by having more satisfied customers.

Several years ago, hardly anyone had heard of limited liability companies (“LLC”). Now businesses operate as LLCs in all states, and the press and media have nothing but good things to say about them. Is all the hype justified? Much of it is, especially where the business involves the ownership of real estate. Limited liability companies offer an unprecedented combination of corporate-like liability protection and partnership pass-through taxation. In addition, if anonymity is a goal, you can achieve this by naming the LLC whatever name you desire so long as it is followed by the words “limited liability company” or a variation or abbreviation of these words.

Unlike limited partnerships, limited liability company “members” don’t have to limit their participation in the firm’s management to protect their personal assets from the firm’s creditors. Yet they can qualify for true partnership taxation.

LLCs also have a number of distinct advantages over S corporations for many businesses. They are not restricted to a single class of stock as S corporations are, so LLC members have a greater ability to allocate gains, losses, deductions, and credits. Also, there are no limits on the number or kind of shareholders, giving LLCs greater access to capital. In addition, LLCs have certain tax advantages over S corporations when it comes to the ownership of real estate.

All of this makes LLCs the entity of choice for holding real estate for start-up ventures. However, should established investments be transferred into an LLC? The answer is maybe. If the real estate is presently held in the name of one or more individuals, the property could and probably should be transferred and held in an LLC so as to achieve the liability protections to which the owners of LLCs are availed. In the case of multiple individual owners, holding property in an LLC will also provide for centralized management of the real estate, avoiding disputes that occasionally arise between individuals holding real estate as tenants-in-common. The transfer of real estate by an individual into an LLC generally will not result in a taxable event for income tax purposes.

Similarly, if the real estate is presently owned by a general partnership, the general partnership can usually be converted to an LLC, thus achieving liability protection, without causing a taxable event for income tax purposes. In fact, the conversion of a general partnership to an LLC can typically be accomplished without even changing your federal identification number because both entities are treated as partnerships under the tax code. There are very few circumstances today in which a general partnership is the entity of choice for real estate investments or for other types of businesses.

If the real estate is presently owned by an established corporation and the real estate has appreciated since it was purchased, the tax cost of converting to an LLC is probably prohibitive because distributing the real estate from the corporation will result in a taxable event.

In summary, most start-up real estate ventures should typically be organized as LLCs, and existing ventures should at least consider converting to an LLC.

If you’re like most people, you don’t like to think about planning your estate. But it’s an important part of ensuring the financial security of your loved ones. One of the easiest and most common tools used in estate planning is a program of giving gifts. Gifts can reduce the size of your estate that is subject to tax while still passing on wealth. Gifts can also serve a function in your income tax planning by shifting income-producing property to others who are in a lower tax bracket. Not only will gifts enable you to remove assets from your estate, but gifts will also enable you to remove future appreciation of such assets from your estate.

While many gifts are subject to gift taxation, you can give away up to $12,000 (2008) per recipient per year free of gift tax. These gifts also do not reduce the amount that you can pass free of estate tax. There is a great deal of flexibility in the types of property that can be transferred. Qualifying gifts can be money, real estate, stocks or other business interests, or even a life insurance policy. The gift may also be made through a trust so that the actual distribution of the property can be made at a time when the recipient has the maturity to deal with the asset.

You can give up to $24,000 (2008) per recipient per year if you’re married and your spouse consents to “split” your gifts. This is useful for spouses who do not own an equal amount of property. The spouse with less property can consent to gifts made by the wealthier spouse, thereby effectively doubling the amount that the wealthier spouse can give away tax free.

One important thing to remember when you make a gift of appreciated real estate is that the recipient must take your basis in the real estate. This means that if the recipient sells the real estate, any gain on the sale will be measured using what you paid for the real estate, not what the real estate was worth when he or she received it. In contrast, if real estate is transferred to another through your estate, the recipient can use the value of the real estate at that time in measuring any gain on the sale of the real estate. This increase in the tax basis is known as receiving a “stepped-up” basis. Consequently, choosing the right asset to give is an important aspect of any gift-giving program.

If used properly, a program of gift-giving can benefit everyone involved. If you have any questions about the best way of using gifts as part of your overall financial plan, please contact us.

A well-known, but sometimes overlooked, way to buy and sell real estate without paying tax at the time of the transaction is through the use of “like-kind” exchanges. In a like-kind exchange, investment property is traded for other investment property. The person transferring one piece of property receives different property but keeps the same basis as that for the old property. That way, the gain is deferred while other tax attributes are preserved.

Of particular interest are the flexible features that make a like-kind exchange an especially useful technique. First, properties do not have to be of identical type to qualify as like-kind. To take a few examples, commercial buildings may be exchanged for unimproved lots, farm land for city lots, and even cooperative housing stock carrying occupancy rights for a condominium interest in the same property.

Second, properties do not have to be exchanged at the same time. Therefore, it is not necessary to have already located the exchange property to make a like-kind exchange (an important consideration if the end of a tax year is looming). It is sufficient that the exchange property be identified within 45 days after the relinquished property is given up and that the identified property be received within 180 days.

To illustrate how these exchanges can work,
consider the following example:
Fred owns an interest in an office building. He bought it years ago for $10,000, but today it is worth at least $100,000. Fred has decided to move to Florida and convert his office building interest into an ownership share in a Florida apartment building. Allison wants to buy Fred’s office building interest, and for tax reasons she wants to own the building interest by December 31. Fred wants to avoid the high tax he would have to pay after a cash sale.

A solution is a deferred like-kind exchange. Fred transfers his building interest to Allison on December 31. Allison agrees to locate and buy a Florida apartment building interest of equal value suitable to Fred. (Fred can even insist that Allison put the purchase price in escrow, so long as Fred has no independent right to use the purchase price.) After Allison finds and buys the Florida property, she transfers it to Fred, and the like-kind exchange is completed. Provided the 45/180 day rules along with other requirements are satisfied, Fred receives the Florida property tax-free, with the same basis and holding period he had in the office building.

In fact, it is even possible to not include Allison in the latter transaction if a Qualified Intermediary is used. For example, Fred could sell his office building to Allison with the proceeds of the sale held by the Qualified Intermediary until Fred identifies a new piece of real estate (must be accomplished within 45 days) and closes on the new piece of real estate (must be accomplished within 180 days). At the second closing, the monies held by the Qualified Intermediary would be paid to the seller of the second piece of real estate and the like-kind exchange would be successfully completed without any further participation by Allison.

As you can see, a like-kind exchange can be an excellent planning tool. Even in situations where it is impractical to arrange a completely tax-free transaction, like-kind exchanges may still reduce the immediate tax consequences of altering your investment holdings. However, as with most tax planning strategies, in order to qualify for like-kind exchange tax treatment and benefit from the accompanying tax savings, certain technical requirements must be met. Careful planning should therefore be undertaken in arranging the transactions.