TAKING TITLE BY DEED ELIMINATING THE DEED-IN-BLANK PROCESS

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1 INTRODUCTION TAKING TITLE BY DEED ELIMINATING THE DEED-IN-BLANK PROCESS REPORT THE PUBLIC POLICY COMMITTEE, EMPLOYEE RELOCATION COUNCIL (ERC), AND RECOMMENDATION TO ERC SBOARD OF DIRECTORS MAY, 2001 At its meeting in the fall of 1999, the Public Policy Committee of ERC formed a task force to examine issues created by or affecting use by ERC members of a one-deed process to transfer ownership of employee homes first to the employer or relocation management company, and then to the ultimate buyer. Use of this blank deed process (sometimes called deed-in-blank or deed-to-blank), in which the employee signs a deed, but with the buyer s name left blank to be added at the time of the outside sale, has been standard practice in the relocation industry for at least two decades, and was originally adopted to reduce administrative steps in the relocation home purchase and sale process, to eliminate procedural complications discussed below, and, in those jurisdictions where permissible, to minimize transfer taxes, recording fees, or both. Recent developments considered by the Committee called into question whether the industry should continue to use the blank deed process. These included federal income and employment tax developments since the decision in Amdahl Corporation v. Commissioner, 108 T.C. 507 (1997), state licensing issues like those that arose in Oklahoma, and increasing uncertainty as to whether use of the process eliminates the possibility of duplicative transfer taxes or recording fees in some states. The Task Force considered all issues brought to its attention, and concluded that ERC should recommend to its members that they use two deeds in the home purchase and sale process, taking title in either the employer (in an in-house program) or the employer or relocation management company (in a third-party program) on the sale of the home from the employee to the employer or relocation management company. At its meeting on May 8, 2001, the full Public Policy Committee adopted the Task Force recommendation. The reasons for that recommendation follow, together with a discussion of the disadvantages that arise in using a two-deed process. In addition, a separate discussion of issues that relate to the timing of the recording of the two deeds is included. Although those issues do not affect the basic recommendation to use two deeds, they will need to be addressed by companies choosing to follow the recommendation. Nothing in this recommendation should be taken to suggest that use of one deed in the past was incorrect, or violated either federal or state rules. Rather, the recommendation is intended to accommodate changed circumstances and recent developments, as described in the balance of the report.

2 REASONS TO USE TWO DEEDS A. Federal tax. Favorable federal tax treatment of relocation home purchase transactions depends upon continued IRS recognition that two bona fide sales have occurred, one from employee to employer, and a second to an outside buyer. Although private letter rulings from the early 1980 s accept the blank deed as not inconsistent with the two-sale characterization, developments since the 1997 Amdahl decision strongly suggest that IRS increasingly will challenge these transactions, and will cite the employer s failure to take separate title by deed as a significant factor in holding that the home purchase costs are taxable to the employee and subject to employment taxes. In Amdahl, the Tax Court held that the appraised value and assigned sale home purchase transactions undertaken by relocation management companies on Amdahl s behalf were not two sales at all, but were instead merely sales by the employees with Amdahl assisting and bearing the costs. A principal factor cited by the court in reaching this decision was the failure to take title by deed in the first transaction. Although the IRS has taken no official position, IRS Employment Tax offices have prepared and are increasingly relying upon a paper citing Amdahl for the proposition that all expenses incurred in relocation home purchase transactions are taxable to employees. In every case where this has become an issue, the blank deed has been cited as the principal factor leading to this conclusion. Its use is difficult to explain to IRS in these cases. IRS personnel are not familiar with the technical aspects of state transfer taxation, and tend to question whether the employer has adopted inconsistent positions with respect to federal and state taxes. It is not clear that this IRS trend will become an official IRS position, or that the position could be sustained in court by the IRS. Nevertheless, in each instance where it has arisen, the IRS has expressed willingness to drop the issue in the future if the employer would take title by deed. A further advantage to using two deeds in the federal tax context is that it would generally support eliminating use of a Power of Attorney in home purchase transactions. A Power of Attorney running from the employee to the employer or relocation management company tends to support the holding in Amdahl that the company is merely acting as an agent to facilitate the employee s own sale, even though there may be independent business or procedural reasons for obtaining a limited Power of Attorney. B. State transfer tax/recording issues. In Private AG Inc. v. Prudential Residential Services Limited Partnership, Associates Relocation Management Company, Inc., and Cendant Mobility Services Corporation, private attorneys are suing, puportedly on behalf of the state of Florida, to recover unpaid

3 taxes and various fines and penalties allegedly resulting from the defendant companies use of the blank deed process in Florida. If the plaintiffs are successful, it has been estimated that the cost to the companies could reach $10,000 per transaction in Florida for a period going back in time some ten years. A similar suit has been filed, but held in suspense, apparently naming in excess of fifty additional defendants, including other relocation management companies and several large in-house programs. While the industry thinks that under the Florida transfer tax statute the deed-inblank process does not require duplicate transfer taxes to be paid, the plaintiff in that case alleges that the sale to the employer or relocation management company using a blank deed does create a taxable event, although that is not the way that Florida s revenue department has informally interpreted the law for many years. ERC s Real Estate Coalition for Cooperative Business Practices has worked hard for passage of legislation to clarify that blank deed transactions are not subject to two taxes, but the outcome is unclear, as is the eventual outcome of the litigation. Although few states have statutes permitting a private lawsuit to recover state taxes, as many as 28 have transfer tax statutes which might, in the future, be interpreted as imposing a tax on the transfer of beneficial ownership by the blank deed process. Consequently, there is the potential for significant potential future exposure for every company engaging in home purchase transactions in continuing to use the blank deed process. In addition to the existence of the Florida litigation, ongoing state examinations of relocation transactions in the context of referral fees and other issues will almost certainly lead to additional jurisdictions questioning the continued use of the blank deed process, or seeking to modify transfer tax laws to address the issue. C. State licensing In 1999, the relocation industry reached an accommodation with the state of Oklahoma, which had been contending that relocation management companies (and inhouse programs) needed to be licensed as real estate brokers in Oklahoma in order to buy and sell employee houses in that state, even though a licensed Oklahoma broker was handling the transactions. This position of the Oklahoma authorities might eventually have required that even relocation counselors who had never set foot in the state be licensed as Oklahoma real estate agents. As a result of the 1999 agreement, however, one of the factual predicates for avoiding licensure in Oklahoma includes a requirement that the employer or relocation management company takes title to the home by deed. Consequently, the blank deed process is not generally used in Oklahoma. Although other states have not yet taken the position that relocation management

4 companies must be licensed brokers in the state, many have licensing statutes similar to that in Oklahoma, and using a two-deed process will be a factor in minimizing the risk in those states. D. Other reasons to use two deeds. 1. Taking title by separate deed, and recording it, will protect against numerous risks now borne by employers. These include the risk that the employee could sell the house to someone else, whose purchase would have priority over the unrecorded interest of the employer; the risk that federal or state tax liens, creditors or judgment liens, or mechanics liens against the employee will arise and achieve priority between purchase and subsequent re-sale of the home; and the risk that death of the employee or a divorce filing before the second sale closes will impact the title. 2. Use of two deeds will eliminate the problem caused by notary statutes in some jurisdictions, which require that the entire document be completed before the notary may legally notarize the employee s signature. 3. Taking title by deed in all jurisdictions will standardize the process used. There are already a number of states where two deeds are often used, for a variety of reasons. These include New York, Washington, Oklahoma, Kentucky, Texas, South Carolina, Florida (since the litigation commenced) and some counties in Maryland. In others, the blank deed is often used. There are clearly benefits to be derived from a standard practice. 4. Generally, taking a deed from the employee will clarify the issues of agency that arise, not only between employee and employer or relocation management company, but also between the employer and the relocation management company. DISADVANTAGES OF TWO DEED PROCESS Although the Committee believes they are greatly outweighed by the reasons given above for using two deeds, it identified the following disadvantages to eliminating the blank deed process. A. Cost In addition to the additional transfer taxes or recording fees that would be incurred, additional costs might include document preparation, title examination fees, and miscellaneous charges necessary in various states. Although these costs are significant, there are ameliorating factors. As noted, companies are already taking title by deed in a number of jurisdictions, so the additional costs are not universal. Moreover, many states have no transfer taxes, so that the additional cost is limited to document preparation and recording, and many states have relatively nominal transfer taxes.

5 B. Additional federal tax gross-up. Generally, it is the seller who is liable for transfer taxes and recording fees, not the buyer. Consequently, when the employer or relocation management company pays the tax or fee, or both, on the first sale, that amount will be taxable income to the employee, reportable on the W-2 and subject to withholding and employment taxes. For those companies that gross up for federal taxes, this will impose an additional cost. C. Lost convenience. To the extent the blank deed process is convenient and less difficult to administer, that advantage is lost. Moreover, there are additional requirements in many jurisdictions that create administrative issues. These include the need for evidence that the corporate official signing the deed to the buyer is qualified to do so, the need for certificates of good standing and the like for corporate transferors in some jurisdictions, and requirements to verify that the company has no outstanding liens, etc, for title purposes. Finally, companies will have to consider whether to provide a general warranty deed, or a special or limited warranty deed to the buyer. D. Taking title by deed will increase the likelihood of the employer or relocation management company being considered to be doing business within a particular state and having to qualify as a foreign corporation, to file tax returns, and to pay tax there. Although states alleviate the total tax cost by apportioning income, differences in tax rates and regimes can increase a company s overall tax cost, and the filing and associated requirements in themselves add complexity and cost. E. In those jurisdictions that have withholding requirements for out-of-state sellers, steps will have to be taken to achieve exemption from the requirement. Although that is achievable in each jurisdiction, the processes to do so may be different than they are when the blank deed is used and the company never has recorded title. Jurisdictions with withholding requirements include California, Georgia, Hawaii, Maine, Puerto Rico, Rhode Island, South Carolina, and Vermont. RECORDING ISSUES Assuming that the employer or relocation management company takes title by deed in its own name, that deed will need to be recorded at some point. Recording not only provides protection against the types of risks noted above, but it is necessary to provide a clear chain of title for title insurance purposes. However, there are issues that arise relating to the timing of recording. This section of the report identifies some of those issues. A. Recording when deed is received.

6 1. Immediate recording achieves protection against liens and other encumbrances arising between purchase and sale. If the deed is not recorded, other claimants may have priority. 2. Recording may trigger due on sale clauses in mortgages. In most cases, the clause would also triggered by the sale to the employer or relocation management company using the blank deed, but recording of a deed in favor of that buyer will usually trigger a notification to the lender. Additionally, the existing mortgage, if any, may have to be noted on the deed or there would be a violation of the warranty or covenants against grantor s acts. 3. In some states, recording of a deed will trigger a reassessment of the property, and result in higher real property taxes being determined for the period during which the employer or relocation management company owned the home. 4. In some jurisdictions, a deed presented for recording does not show up on the records for a period of time, making title research more difficult thereby potentially delaying the closing with the outside buyer. 5. Notification may be generated for water and sewer adjustments, which may occur after the closing with the outside buyer. created. 6. Accounting and balance sheet or financial presentation issues may be B. Recording the two deeds simultaneously (presumably, at the time of the transfer to the third party buyer). 1. In some jurisdictions, there is only one tax or recording fee when backto-back deeds are recorded. 2. Simultaneous recording may appear inconsistent with the relocation industry two-sale position. 3. It is more likely the company will be held to be doing business in a state if it holds recorded title for some period of time. may be lost. 4. Protections against some of the other adverse interests noted above RECOMMENDATION Having carefully considered all of the issues noted above, the Committee concluded that it would be in the best interest of the members of ERC to use two deeds in relocation home purchase transactions. In the view of the Committee, the advantages of doing so far outweigh the costs and other disadvantages identified. Consequently, the Committee

7 believes ERC should recommend to its members that they take title by deed in home purchase transactions. ERC understands that there may exist circumstances which would alter a particular member s degree of risk or costs in a manner that may be different than that of other members. Accordingly, the final decision must rest with ERC members themselves. Members should consult their own tax and legal advisors, and make their decisions based on the advice they receive.