California Real Estate Salesperson Exam Prep PDF

1 Notice: This material is solely the property of Berkshire Hathaway HomeServices California Properties, and is made available for your use for the purpose of assisting you in passing California Bureau of Real Estate Salesperson Examination. Use of this material for...

1 Notice: This material is solely the property of Berkshire Hathaway HomeServices California Properties, and is made available for your use for the purpose of assisting you in passing California Bureau of Real Estate Salesperson Examination. Use of this material for sale, distribution or reproduction without prior written consent of Berkshire Hathaway HomeServices California Properties is strictly forbidden. 2 Berkshire Hathaway HomeServices California Properties Real Estate Schools Salesperson Review Notes I: Introduction These notes are a summary of information that will appear on your real estate examination. The Bureau of Real Estate has provided information on the importance of each subject as it will appear on your examination (refer to Exhibit “A” for details.) It is necessary that you identify any area of weakness in your studies and strengthen those areas. One area which we are sure will help a great deal is VOCABULARY. At least 25% and maybe as much as 50% of the required knowledge to pass the exam centers on vocabulary. Yes, math may be on your exam. A grade school level of knowledge in this area is all that is required to do the math questions. Good luck. 3 II. HELPFUL TIPS TO HELP YOU TAKE YOUR REAL ESTATE EXAMINATION AND PASS A. Basic Procedures 1. Simulate State Examination testing conditions when taking the exam. 1) Time: Pace yourself at a rate that approximates the amount of time you will have to take the state examination (about 1.25 minutes per question). Total test time of 3 hours, 150 questions. 2) Use the procedures to take the examination that we recommend. Doing so will assist you to use your time most effectively and efficiently as well as to avoid making careless mistakes. 3) When taking the state examination you cannot smoke cigarettes, drink coffee or soft drinks, or eat food. Therefore, do not do so when you are taking the practice tests. 2. Study the Crash Course Review Notes many, many times. 3. Do Study real estate practice relating to the residential resale market, the largest number of real estate agents work in this field; therefore, the Bureau of Real Estate focuses the examination toward this type of real estate practice. B. Specific Pre-Examination Procedures 1. Make a reconnaissance trip to the exam site. a. Preferably make the trip at the same time and day of the week that you will be taking the state examination. b. Determine the route from your home to the examination site. 4  c. Locate where you are going to park your car and what the cost, if any, will be to do so. d. Find the building where you will be taking the examination. 2. Before you leave your home, check to insure that you have with you the following: (most of these items were suggested by our students.) a. The letter you received from the Bureau of Real Estate stating the date, time and location you are scheduled to take the examination. b. Form of positive identification (such as your driver license) to prove that you are the person named in the letter. Picture ID will be necessary. c. Money to pay for parking your car should there be a parking fee. 3. At the examination site: a. You should have time to relax, have another cup of coffee and review your notes, etc. before entering the examination room. Watch your time. You will not be admitted late. b. You cannot refer to your notes after you enter the testing room. There is no advantage in being the first person to enter the examination room. c. Have all of the items mentioned above in hand for “check in” by the exam proctors. d. If the seat you are assigned in the examination room is situated so that you may experience distractions while taking the test, when it is appropriate, ask an examination proctor if you can move to a vacant seat. *Note: DO NOT USE YOUR CELL PHONE FOR ANY REASON WHEN IN THE EXAM ROOM C. Write down the Memory Aids 1. Most students use memory devices to assist them to remember information that they will use during the examination. Examples of these are: M-A-R-I-A, D-U-S-T, No Darn Fooling Around, T.T.I.P., 640, 5,280 and 43,560. 2. After the examination-taking period has commenced and it is permissible for you to do so, write these items on the scratch paper worksheets (if provided). 5  Note: Do not lay out a township with section numbers until those questions are asked. In some exams, the State may not ask any section number questions. D. How to Take the Examination By following a proven procedure for taking the state examination, you can maximize the score you will earn on this important test. You can increase the probability that you will pass the examination and minimize the chance that you will make careless errors. You can be a more effective and efficient test taker. You will insure that you spend the time allotted for the examination in a manner that is most beneficial to you. 1. The First Time through the Examination The Three Step Approach a. Each question should be done in the same manner. This consists of the following approach: 1) Read the question carefully, but not slowly. Do not waste time. 2) Read all four responses, but do not answer the question. 3) Re-read the question. b. The second time you will read it much more knowledgeably because you know what the four responses are. c. Be aware of limiting words in the question, e.g., is it a negative question? d. If you are absolutely certain of the correct answer, mark it on your test. e. If you are NOT absolutely certain which of the four responses is best, skip the question and move to the next one. (Go through all 150 exam questions using same procedures). f. You will first answer the questions that are the easiest and can be completed quickly. Remember, all the questions count the same: the easy ones and the hard ones; the questions that you answer quickly and those that take a long time to determine the best response. g. Expect questions that will ask you: “all of the following are correct except:” 2. The Second Time Through the Examination 6  a. This time you will only look at the questions you skipped. These are the questions which you did not know the answer the first time you went through the test. b. Use the same Three Step Approach on each of these: read the question carefully; read all four responses and then re-read the question. Then ask yourself the question (as you did the first time through): “Do I absolutely know the answer to this question?” c. Often you will find that the second time you go through the examination, you will know the correct response because some later questions in the examination either gave you the answer or “triggered your memory.” When this occurs, mark the proper answer bubble and go to the next question that you skipped. 3. The Final Time through the Examination a. You now will work on those questions that you could not answer the first two times through the examination. b. Approach the question differently this time. 1. Read the question. 2. Read response “A” and ask yourself the question: “Is there any way that Response “A” can be the answer to this question?” a) If you conclude that “A” could not be the correct response, you can eliminate “A”. 3. Follow the same procedure for response “B”. 4. Then for “C” and following that for “D”. c. If you can eliminate three of the responses, you have determined the correct answer to the question. Usually it is relatively easy to eliminate one or two of the incorrect responses. d. Even if you may not be able to eliminate responses down to one, make certain that you answer the question. 1. There is no penalty for guessing. Your score on the examination will be the sum of correct responses that you have made. Mark an answer for every question, even if it is only a guess. 7 4. Do Not Change an Answer to Another Choice that Later Appears to be Better than Your Initial Response - Unless: Obviously, this does not mean that in checking, when you discover that you have misread a question or made an error in computing the answer to a math problem that you are not going to correct these errors. We mean that you do not change an answer solely because, at a later time, another choice now “looks better” than your initial response. All things being equal, your first response tends to be better than a later “second guess”. 5. Return to the Materials that were given to you by the Proctor: E. Additional Comments Regarding “taking a break” during an examination: 1. Some students find it necessary or beneficial to “take a short break” during the examination. They must go to the restroom, need a drink of water, must smoke a cigarette (if allowed at the test site), or believe that they should “walk around a bit” to calm their nerves. 2. This means that they must leave the examination room. Before doing so, the examinee must have the permission of an examination proctor. 3. If you do find it necessary or desirable to take a break, you should not: a) Waste time. b) Talk to other examinees who are also taking a break. You do not want to give the appearance that you might be violating examination security. c) Make telephone calls. 4. Don’t even think of rushing to your car to check your textbook or notes for assistance in your exam taking. Remember examination security. WELCOME TO THE PROFESSION OF REAL ESTATE Exhibit “A” Salesperson Examination Content* Property Ownership and Land Use Controls and Regulations (approximately 15% of exam) Laws of Agency (approximately 14% of exam) 8 Valuation and Market Analysis (approximately 14% of exam) Financing (approximately 9% of exam) Transfer of Property (approximately 8% of exam) Practice of Real Estate and Mandated Disclosures (approximately 25% of exam) Contracts (approximately 12% of exam) *Subject to periodic update -Refer to California Bureau of Real Estate website for updates/revision. NOTE: Sales person exam consists of 150 questions and allows 3 hours for completion. Examinees must correctly answer at least 70% (or 105) of the questions on the test to pass and become eligible for a salesperson license. 9  Crash Course Table of Contents Chapter 1 Property-Ownership, Controls, and Regulations Page 11 Chapter 2 Transfer of Property and Tax Implication of Personal Ownership Page 30 Chapter 3 Contracts in Real Estate Page 47 Chapter 4 Real Estate Finance Page 60 Chapter 5 Practice of Real Estate and mandated Disclosure Page 77 Chapter 6 Law of Agency Page 99 Chapter 7 Valuation/Appraisal of Real Property Page 105 10  CHAPTER 1 Property – Ownership, Controls and Regulations A. Classes of Property 1. Real Property is defined as land, anything attached to the land or appurtenant to (belonging with) the land (such as an easement appurtenant or stock in a mutual water company). Real property is immovable. 2. Personal property is anything that is not real property. It is movable. Documents such as trust deeds, grant deeds and mortgages are personal property even though that to which they refer is real property. a. A chattel real is a lease, and is personal rather than real property. b. Crops may be a real or personal property. Crops which must be replanted annually (fructus industrials) are personal property (e.g. corn, wheat, etc.). Crops which replenish themselves (apple, oranges, etc.) are real property until they are cut, mortgaged or sold. All crops, when cut, mortgaged or sold, become personal property. 3. An item of personal property permanently attached to real property becomes real property – and is called a “fixture”. It is incorporated into the land. a. The five tests of a fixture are: (MARIA) 1) Method of attachment 2) Adaptability of the item 3) Relationship of the parties 4) Intent of the parties 5) Agreement between the parties b. Agreement of the parties is the most important test. c. A trade fixture is personal property. 4. The stock of a mutual water company is owned by the landowners served by the company. This stock is appurtenant to the land. The ownership of the stock accompanies title to the land. Thus, when a parcel is sold, the buyer of the land acquires the ownership of the stock. 5. Riparian rights are the rights of an owner of land bordering a watercourse to the reasonable use of water from it. 11  6. Accession is the addition of property by natural means (such as accretion) or unnatural (such as the addition of fixtures – annexation). 7. Accretion is the gradual addition to a shore or bank by the deposit of alluvium. This benefits the landowner. 8. Reliction is an increase in land caused by the permanent withdrawing of a body of water. 9. Avulsion is the sudden and violent tearing away of land, as in floods. The land torn away belongs to the original owner, who has one year to reclaim it. 10. A property owner’s boundary along an ocean is the mean high tide line. B. Estates An estate is what a person owns. It is the ownership interest a person has in real property as to a degree, quantity, nature, duration or extent of interest. There are two types of estates – freehold estates and less-than-freehold estates. There are two types of freehold estates – an estate in fee for an indefinite duration or a life estate for an uncertain duration. Less-than-freehold estates normally have a duration that can be determined. 1. Freehold Estates a. Fee Simple Estate is also known as estate in fee, and estate of inheritance or the fee. It is the greatest or least restricted interest an owner can have in real property – ownership of the full bundle of rights. It includes present as well as future interest in the title. Characteristics: (1) Freely transferable – May be sold or given away. (2) Freely inheritable – May be willed to others. (3) Indefinite duration – in perpetuity – forever. Types: (1) Fee simple absolute – the estate has absolutely no limitations or qualifications. (2) Fee simple defeasible – The estate may be defeated by a condition subsequent to the grant, which if breached, may change or terminate the estate. c. Life Estate 12  Estate measured by the life of a person holding it or the life of another. It can be sold, encumbered, or leased, but only for the term of the life estate. It can be created by a deed or will. It is a present, but not future interest in the title. Characteristics: (1) Transferable – Limited to the term of the estate. (2) Inheritable – Only when measured by the life of a third person. (3) Uncertain duration – Measured by life of person(s); therefore, the exact time of termination is unknown. Types: (1) An Estate in Reversion is a future interest. It is the right to future possession and use of property by the person who created the estate. When used in connection with life estates, it means that the estate will pass back to the grantor. (2) An Estate in Remainder is a future interest and the right to future possession and use of property by a third party. The third party is called the remainder man, remainder person or remainder. Rights of the Life Tenant: (1) Sell it- however, the grantee’s interest (the one who receives it) ends when the life estate terminates. (2) Lease it- however, the life estates lessee’s interest ends when the life estate terminates, if it is before the lease ends. 3. Less-Than-Freehold Estate (leasehold estate or chattel real) Property, not real property. This is the legal interest in real property held by a tenant who is leasing or renting. a. Estate for Years An estate for years is for a fixed term. It does not have to be for only a year, but if a definite end date is stated, it nevertheless is known as an estate for years. It is not automatically renewable and does not require notice to quit at the end of the lease (must be renegotiated). At the expiration of the lease, terms must be mutually renegotiated. b. Estate from Period to Period Another kind of agreement, probably the most common for residential use, is the estate from period to period, also known as periodic tenancy. This is the typical 13  month-to-month tenancy that requires notice to quit. It automatically renews itself unless terminated by landlord or tenant. Most common document used in this estate is a rental agreement. c. Estate at Will When there is no written agreement between the landlord and tenant, the tenancy is known as an estate at will. The tenancy may be ended by the unilateral decision of either party. There is no agreed-upon termination date; however, and either party must give notice before ending the tenancy. d. Estate at Sufferance An estate at sufferance occurs when a tenant occupies the property without paying rent and without the permission of the landlord. C. Methods of Holding Title- Forms of Ownership 1. The manner in which title is held is called vesting. In severalty means “alone”, “individual”, not “several”. Thus, property held in severalty is owned by one person alone and not by several people together. A corporation (being a “legal person”) owns property in severalty. A city is a municipal corporation; therefore, a city takes title in severalty. 2. When there is more than one owner of property (co-ownership), title can be held as tenants in common, joint tenants, community property, general partnership or limited partnership. a. Tenancy in common- when parties, none of which are married to each other, jointly own a property, the presumption is that they are taking title as tenants in common. There is no right of survivorship in this form of ownership. (1) The only unit of a tenancy in common is that of possession. (2) A tenant in common can transfer his/her individual interest to a third party if he/she desires to do so. (3) The interest of the tenants in common need not be equal. (4) The number of tenants in common owning a specific parcel is not limited. b. Joint Tenancy- There are four unities of joint tenancy: time, title, interest and possession. T.T.I.P. (1) The most significant feature of joint tenancy is right of survivorship. Note: A corporation (legal being considered to have a perpetual existence) and an individual (natural being) cannot hold title to the same property at the same time as joint tenants. (2) The whole title is vested in each tenant. Therefore, when a joint tenant dies, that person simply drops out of the estate. 14  (3) The remaining joint tenants do not acquire title to the decedent’s portion by inheritance, because they already owned the whole estate. Consequently, the will of a joint tenant has no effect upon the ownership of the property held in a joint tenancy. (4) A joint tenancy must be created at the same time and by the same instrument (a deed or a will). Must be specified in document. (5) Each joint tenant must have an equal interest in the property. (6) As with any form of co-ownership, each joint tenant has the right of possession of the property. This unity (possession) is the only common feature in all other co-ownership forms. (7) If a joint tenant conveys all or part of his/her interest to another person, that person(s) would hold that interest(s) as a tenant(s) in common with the other joint tenants, who would retain a joint tenancy relationship with each other. (8) A weakness of a joint tenancy holding is that it can be severed by voluntary transfer of an individual joint tenant or by operation of law. The sale of interest by an owner does not require permission of the other owner (owners). (9) If title to a property is held by two or more persons as joint tenants and one of them transfers their interest to another party, the new owner is not a joint tenant. This is due to the fact that the requirement of time has not been met. The new owner is now a tenant-in-common. Had the original group of owners (3 or more) been joint tenants, the non-selling owners remain as joint tenants, as to themselves. (10) If an individual co-owner encumbers share and dies, creditor who holds lien on joint tenancy property has no claim. (11) Death Certificate and Affidavit of Death of joint tenant must be filed to obtain marketable and insurable title. c. Community Property (1) Only a married couple or couples registered under the Domestic Partnership Law can hold title as community property. (2) All property acquired by a married couple during the marriage is community property except that which is acquired by one of the two via inheritance or gift. (3) Property acquired by one spouse by gift or inheritance during marriage could be separate property. (4) Income generated by separate property can be separate property of one of the spouses. (5) Separate property can be converted to community property by commingling. (6) When a married couple acquires property, there is a presumption that title to it is held as community property. (7) Both spouses must execute a conveyance of community property. (8) Each party shares the management of the property. 15  (9) One of the two parties can bind the community estate to a listing contract without the signature of the other party. This, if either execute a listing contract that provided that the broker would earn a fee if broker produced a ready, willing and able buyer for the property. The total community estate is responsible for paying the broker the agreed fee. (10) The unique quality that joint tenancy and community property share is that the owners have equal interests. d. General Partnership (1) May be created by a written agreement, an oral agreement, or by estoppels (actions of the partners causing third parties to believe that they are partners). (2) All general partners are personally liable to third parties for all partnership debts. (3) The Law of Agency applies to a partnership, as each partner acts as the agent of the other partners; therefore, one partner cannot take advantage of the other parties. (4) Each partner has equal right of possession of partnership property. (5) A partner cannot sell, lease or encumber his interest unless all partners agree. e. Limited Partnership (1) There must be at least one general partner. (2) There must be a written contract with each limited partner. (3) The liability of limited partner is limited to the amount of his investment. (4) Limited partners cannot help manage the business/property. Limited partners can remove a general partner, but cannot participate in the day-to- day management of the business or property. 16  f. Corporation (1) A corporation is a legal person. Therefore, it holds title in severalty. (2) A corporation could be a tenant in common. However, it could not hold title as community property or as a joint tenant. (3) An advantage to a stockholder is that he/she has limited liability; his/her loss is limited to the amount he/she has invested. D. Legal Descriptions 1. Metes and Bounds In a metes and bounds description, a surveyor uses boundary markers and measures the distance from marker to marker to determine a property’s perimeter. The term metes refers to distances, which may be measured in inches, feet, yards, compass bearings, or rods. Bounds are natural or artificial boundaries, such as rivers and roads. Single monuments, or markers, such as rocks, fences, iron pipes or other natural or artificial objects also may be used. 2. Recorded Maps or Lot and Block System (Urban Legend) All city property and town property was at one time rural or agricultural land which was later subdivided into lots for sale as the cities grew and expanded. Before any lots in the subdivision can be offered for sale to the public, the law requires that a map of the subdivided tract be filed in the recorder’s office showing the location and identity of the lots. Parcels can then be identified in a form similar to the following description: Lot 25, Block 36, Tract 1218, in the City of Bishop, as per Map recorded in Book 22, Page 28, Records of Myers County. This description means that Lot 25 is contained in a larger area described as “Block 36” which is contained in a still larger area known as “Tract 1218”. One could easily locate Lot 25 by obtaining Book 22 at the recorder’s office, turning to Page 28, and noting its location and size. The map on Page 28 would show the street on which Lot 25 fronts and the intersecting streets abutting the block. Sometimes a tract will be identified by a name instead of a number; for instance “Vista del Oro Tract”. 3. U.S. Government Survey; Rectangular Survey System (Rural Land) The largest survey areas are known as “townships”. The United States Survey General has surveyed the entire country and fixed imaginary lines. These lines are known as base lines, which run east and west, and meridian lines, which run north and south. These base and meridian lines are used as the starting place for numbering townships. 17  While base and meridian lines are national lines, they may be given local names as they run into each state. In California, we have three base and meridian line districts: The San Bernardino Base and Meridian, the Mount Diablo Base and Meridian, and the Humboldt Base and Meridian. In land description they often are indicated by the initials SBB&M, MDB&M, and HB&M. These reference points serve to identify the location of and property within their area. Townships are six-mile squares. Each township contains 36 sections, 25 of which are perfectly square one mile areas, and 11 imperfect ones die to the curvature of the earth. While the correct identification of a given township is important in preparing a legal description, the State Exam is more concerned with the subject of sections. Sections Moving in closer from the townships, the next smaller tracts or areas are known as sections. Like townships, sections are also identified and located by numbers. Sections are 1-mile squares in every township. Because townships are 6 miles by 6 miles, there are 36 square miles or 36 sections in a township. Sections are always numbered and located in the same relative positions in any township. As illustrated in this township plat. 18  Note: Top of map is north. Those sections numbered outside of the heavy black line are in adjoining sections. Those within are in the same section. Example questions: a. What section is due east of Section 1? Answer: Section 6 of the adjoining section. Question: b. What section is due south of Section 9? Answer: Section 16. Facts about Townships and Section Meridians run north and south Baselines run east and west Range Lines run north and south, parallel to the principal meridian every six miles. Township Lines run east and west, parallel to the baseline, every six miles. Sections are one mile by one mile, 36 in each township and contain 640 acres. 5,280 feet = one mile 43,560 square feet = one acre 19  640 acres = one square mile 16.5 feet = one rod Four miles = distance around a section/square mile 24 miles = distance around a township Note: An address is acceptable for social purposes and to receive mail; it is not considered a legal description. E. Government and Real Property In the United States, the government has sovereign rights over property. These rights are obtained from the people. As it states in the federal constitution, “We the people”, delegate certain powers and authority over ourselves and our property (memory aid: P.E.T.E.). 1. These powers are: a. Police Power The fundamental function and power of government is to regulate for the common good, which is done by police power. (1) Police power cannot be delegated (2) It pays no compensation for its restrictions (3) It includes zoning, building codes, license laws and other regulations to protect the public health, welfare and safety of the people. It also includes rent controls and discrimination laws. b. Eminent Domain – Condemnation Because the public has the overriding right in property, the government has the power to take private property on behalf of the people. If the government takes private property for a public purpose, it is done through a process called “condemnation” and the government must pay just compensation, which usually is fair market value. Recent U.S. Supreme Court decision allows the taking of private property for private use providing it is for public good. Note: Inverse condemnation is the opposite of eminent domain. With inverse condemnation, a private party forces the government to pay just compensation if the property value or use has been diminished by a public entity. c. Taxation The government must have money to carry out its functions, and this is done through taxation. The power of taxation often goes considerably beyond that purpose and is used to regulate the behavior of the people. Failure to pay real 20  property taxes for five years can result in the title to that property being sold by the state. d. Escheat California law presumes that every person who dies has an heir who could take title to the decedent’s property. Sometimes, however, it is impossible to locate an heir. The Attorney General acts on behalf of the state to bring a claim against the estate and, if no claimant comes forward within five years, title to the property vests in the state. State will attempt to find a public need for the property. If no need is found, the property will be sold by auction to the highest bidder. 2. Public Restrictions and Control The enabling acts of the State Legislature under its police power, authorizes the state to restrict the use of land and buildings. This is done through planning agencies and the enactment of zoning laws and ordinances. Purpose is to protect against uncontrolled growth, protect public health and preserve compatibility. a. Planning Agency Every city and county in California must have a planning agency which is usually called a planning commission. (1) Duties It prepares and adopts a master plan for the city’s or county’s long term physical development which includes: Pattern of public streets Arterial highway traffic flow Adequacy of rail, water, air and intercity transportation Planning commissions must hold public hearings 21  (2) Zoning Zoning ordinances are other examples of police power. Zoning ordinances are carried out using zoning classifications and maps and specify permitted uses, heights limitations and maximum density restrictions. Zoning classifications and symbols: A -Agriculture C -Commercial R -Residential M -Manufacturing R-I -Single family R-3 -Multiple Units (3) Zoning Changes/Deviations (a) Amendment is a zoning change for an entire area. Could cause nonconforming use. (b) Nonconforming use allows owner to continue present use that no longer complies with current zoning. -Sometimes called “grandfathering” -Owner may not enlarge improvement or discontinue its use. (c) Variance allows individual owner to vary or deviate from strict compliance with zoning in order to relieve or prevent economic hardship. It does not change regulation. This pertains to land use. (d) Conditional use is a specific type of variance allowing a different use. Owner obtains a special use or conditional use permit. This pertains to structure use. (e) “Downzoning” is a zoning change from dense to less dense usage. Commercial to residential. No compensation for downzoning. (f) “Spot zoning” is a reclassification of a small area of land for use that does not conform to the surroundings. 22 1. Subdivisions Map Act- grants cities and counties control over the design (physical improvements) of a subdivision (streets, sewers, etc.). Cities and counties develop master plans (also called “general plans”), showing the location of streets, freeways, commercial districts and seismic activity zones, etc. Master plans are implemented by zoning laws. - Regulates subdivision of two or more contiguous parcels - Subdivided submits maps (parcel map, tentative map, final map) to obtain local approval. Required Environmental Impact Reports (EIR) - Final map includes any dedications. 2. Subdivided Lands Act –designed to prevent fraud. It is regulated by the Real Estate Commissioner (State). The commissioner will issue a Desist & Refrain order to stop violations. The Subdivided Lands Act applies to subdivisions of five or more parcels. Therefore, a two, three, or four parcel subdivision is regulated only by the Subdivision Map Act. Prevents fraud misrepresentation and deceit on the public in the marketing of subdivisions. Requires a series of reports: Preliminary Public Report allows developer to accept reservations. Any deposits are fully refundable on demand. (Pink report). Conditional Public Report allows developer to enter into binding contracts under Commissioner’s Conditions. Final Public Report is required prior to sale and must be signed by buyer to show receipt (White receipt). 3. Interstate Land Sales Full Disclosure Act (ILSFDA) Federal law requires approval for small number of subdivisions and regulates sale of unimproved residential lots sold in interstate commerce. Subdivision is exempt if all lots are 20 acres or larger. Registration and disclosure requirements apply if subdivision has 100 lots or more. California Final Report satisfied disclosure requirements. Gives buyer a right of rescission if property hasn’t been inspected by buyer or if property report was not received. 23 G. Private Control of Real Property Private restrictions are created in the deed at the time of sale or in the general plan of a subdivision by the developer. For example, a developer may use a height restriction to ensure views from each parcel in a subdivision. 1. Covenant – An agreement to do or not to do certain things – a promise. a. Created in agreement or a document conveying title. b. Enforced through a court action called an injunction, which is a court order compelling or prohibiting an act; or for damages. c. Runs with the land, and passes with the land to a newer owner. An example of a covenant might be that the property may be used only for a specific lawful purpose. 2. Condition Subsequent – An if in the conveyance of title which, if not met, may result in loss of title to the original grantor or heirs who may claim title by forfeiture. It can be created only by a document conveying title. The condition is effective after title passes. Runs with the land – for the benefit of subsequent grantees; and Creates a defensible estate Conditions are always stronger than Covenants. 3. Conditions Precedent – A condition imposed on the person, not the property, that must be met prior to the transfer of title and it does not run with the land. If there is a conflict between the zoning requirements and deed restrictions, the most restrictive will prevail. If there is a conflict between the Uniform Building Code and local building code, the one that provides the most safety (the most restrictive) will prevail. Covenants, conditions and restrictions are void if they are unlawful, impossible to perform or in restraint of alienation. Therefore, a deed restriction prohibiting “For Sale” signs is illegal, but the signs may be limited to a reasonable size. Real estate agents are charged with the deputy of disclosure to inform purchaser of C.C. & R’s as to availability of copies, such as from seller, homeowner association and/or County Recorder. 24 H. Encumbrances – Burdens on property which include money burdens (liens, such as trust deeds, mortgages, taxes, judgments, etc.) Buyers commonly purchase encumbered property. 1. Liens - money encumbrances placed against the property either voluntarily (with the owner’s consent) or involuntarily (without the owner’s consent). a. Types (1) Specific Liens – burden on a particular parcel (mechanic’s lien, trust deed, attachment, property tax, lis pendens). (2) General Liens – Burden any and all property of the owner in the county where they are recorded (judgment lien and income tax lien). b. Voluntary Liens – mortgages and trust deeds. c. Involuntary Liens: (1) Mechanic’s Lien- the California Constitution allow mechanics, craftsmen, material men and laborers the right to record a lien against property, if they perform work and are not paid. The procedure to record and enforce the lien can be found in the California Civil Code. (2) Preliminary 20-day Notice In order to be eligible to record a claim of lien, the person performing the work must notify the property owner that he or she is working on the property. Prime contractors provide notice by virtue of their contract. Most other contractors (such as sub-contractors) who are not directly in contract with the owner must use the preliminary 20-day notice. (2) Notice of Completion The owner may record a Notice of Completion stating that the work has been performed. (3) Time Limits for Court Action A time limit for recording a claim of lien applies to all claimants. If a Notice of Completion If a Notice of Completion has been recorded has not been recorded Contractor has 60 days Everyone has 90 days after All others (subs) have 30 days completion of the project 25 Claimant must start court action within 90 days from the filing of claim or it will become automatically ineffective. Claimant may have up to one year if credit terms are involved. (4) Priority The priority of a mechanic’s lien jumps backward in time to the date that the entire project began and could take priority over a trust deed recorded prior to the recording of the lien. (5) Notice of Non-Responsibility A recordable document that protects a title owner against a mechanic’s lien created by parties in possession, (such as tenants) for unauthorized work, if within 10 days after acquiring knowledge, the owner records a notice at the office of the Recorder in the county in which the property is located and posts the document on the property. Notes: (1) Government liens always have priority. Multiple government liens have parity with each other. (2) All mechanics’s liens date back to the beginning of the improvement which is earlier than the date of recording. This is different from judgment liens which take effect as of the date of recording. (3) There is a limited period of time in which to file (record) a mechanic’s lien. All of the following will affect the filing of the mechanic’s lien: notice of nonresponsibility, date of completion of the project, and date of cessation of labor. (4) Lis Pendens – notice of pending litigation concerning title or possession of real property. A lis pendens must be recorded and once recorded clouds the title, pending the outcome of the lawsuit. A lis pendens may be removed without court order. (5) Attachment Lien (Writ of Attachment) – property is held by court order as security for a possible judgment in a pending lawsuit. An attachment lien is valid for three years. (6) Judgment Lien – when an “Abstract of Judgment is recorded, it creates a court ordered general, involuntary lien upon all real property of the debtor located in the county of recordation. A judgment lien is valid for ten years and enforced by way of an “execution sale.” The court orders the sale of property to satisfy a judgment with a “Writ of Execution”. I. Non-Money Encumbrances (Easements, Encroachments, and Restrictions) – effect the physical condition or use of the property. 26  A. Easement- the right to enter or use another person’s land within definable limits. It may be created for any length of time and it is irrevocable during the time limit specified. All easements are real property. Definitions: (1) Dominant Tenement- the land that gets the benefit of the easement; (2) Servient Tenement- the land that is crossed by an easement, the land that is encumbered (burdened) by the easement; (3) Appurtenant Easement- benefits the land of the dominant tenement. The buyer of the dominant tenement automatically receives the easement. The dominant and servient tenements of an appurtenant easement need not abut (touch) each other; (4) Easement in Gross- benefits a person or corporation (e.g., a utility easement for power lines). B. Creation of an easement (1) Express grant or reservation- cannot be lost by non-use (2) Easement by Prescription/Prescriptive Easement: An easement recognized by the courts after fulfilling specified requirements (example: open and notorious use for five continuous years). (3) Easement by Necessity: An easement created by a court to prevent landlocked property. C. Terminated multiple ways depending on how it was created. Example: (1) Merger of dominant and servient tenement. (2) Release, for example, by dominant tenement holder with quitclaim deed. (3) Non-use/Abandonment Easement by prescription terminates after 5 years of non-use. (4) Quiet title action in court. 27  D. Encroachments An encroachment occurs when part of an improvement extends over the boundary line between properties. Fences and buildings are typical forms of encroachment. Even the roof eaves of a building can be an encroachment if it extends into the airspace of a neighboring lot. 28  CHAPTER 2 Transfer of Property and Tax Implication of Property Ownership A. Methods of Acquiring Title 1. Deed The most common method of acquiring title to real property is by use of a Deed. In this document, the conveying party is the grantor and receiving party is known as grantee. In order for a deed to effectively transfer title to real property the deed must be delivered by the grantor and accepted by the grantee. Delivery must take place during the life of the grantor, and it must be the intent of the grantor that title be transferred immediately. Title passes when the deed is delivered and accepted. Delivery contingent on a future event, such as the death of the grantor, would not be valid. Possession of the deed by the grantee, or the recording of the deed, presumes a valid delivery. a. Voluntary Deeds (1) Grant Deed (a) A grant deed is the most important type of deed, and the one most commonly used, and is presumed to be fee simple. The word “grant” in the granting clause legally binds the grantor (seller) to two implied warranties to the grantee (buyer). - Grantor has not previously conveyed the title. - Grantor has disclosed to the grantee all encumbrances he or she has placed on the property or the encumbrances are visible to the grantee. (b) The grant deed may be used to convey after-acquired title – title that will be acquired by the grantor at a future date. It is a type or “pre-granting” of title prior to actually holding it. (2) Quitclaim Deed (a) The word “quitclaim has to be in the granting clause. Unlike the grant deed there are NO warranties with a quitclaim deed. (b) NO after-acquired title is conveyed because it only conveys the grantor’s current interest, if any. 29  (c) Used to: - Clear minor defects in the title. - Relinquish any interest in real property that the grantor has at the time of the conveyance. - Convey good title to real property, including any easements. - Clear a cloud on the title which is any condition affecting the title in a negative manner. - Relinquish title to an adverse possessor. (3) Gift Deed A grant or quitclaim deed that is given in return for consideration of love and affection. If the purpose of the deed was to defraud any creditors, or make the grantor insolvent, the creditors may be able to have the deed set aside. (4) Warranty Deed Valid in California, but is seldom used here because buyers prefer title insurance as title protection. In a warranty deed, the grantor expressly warrants the title is good by the wording in the deed and he or she can be sued on the terms expressed. (5) Reconveyance Deed The deed conveying bare legal title back from the trustee to the trustor is used to cancel a trust deed when the promissory note is paid in full. b. Involuntary Deeds (Must be recorded to be effective) (1) Sheriff’s or Marshal’s Deed Used to convey the debtor’s title to the buyer under a court of foreclosure proceeding or the execution of a judgment. (2) Tax or Controller’s Deed Used to convey title held by the state at the end of the tax sale. (3) Trustee’s Deeds Used to convey the debtor’s title to the buyer under a private foreclosure sale. Used when foreclosing a deed of trust (trust deed). 1. Essential Elements of a Valid Deed a. In writing b. Competent grantor-conveying party 30  (1) 18/sane (2) As in Contract Law, signing party (grantor) may be an emancipated minor that is under 18 years of age and/or (a) Court approved emancipation; or (b) Legally married; or (c) Member of U.S. Military/National Guard c. Must designate a grantee-receiving party d. Granting Clause (Words of conveyance) (Shows intent to convey interest in property) e. Adequate description of the property (Does not have to be legal description) f. Executed (signed) by grantor(s) For valid deed to be effective and transfer title, it must be: Delivered by grantor Accepted by grantee Note: Not essential for a valid or effective deed: consideration, date, grantee signature, legal description, Habendum Clause (“to have and to hold”) recording, escrow or title insurance. 2. Adverse Possession Ownership recognized by the courts after fulfilling five essential elements: a. Open and notorious occupation- without hiding fact from anyone. b. Continuous for five consecutive years- cannot abandon that property during the five years. c. Hostile to the interest of the true owner- without owner’s permission. d. Held under a claim of right or color of title. (1) Claim of right- Adverse possessor asserts claim that he/she is the owner. (2) Color of title- Holds document appearing to give good title (for example, a forged deed). 31  e. Payment of taxes for five consecutive years. Note: Title acquired by this method is usually not insurable until it has been verified by court decree. 3. Acquired after Death of Owner (Probate) a. Probate When properly drawn, a will names an executor to act as the decedent’s representative in ensuring that the terms of the will are carried out. Probate is the name of the court process that determines the decedent’s heirs and creditors, pays debts owed by the estate, and transfers title to any remaining property from the decedent to the decedent’s heirs. If there is a will, the decedent’s representative presents the will to the probate court and receives permission to carry out its provisions. Sometimes the deceased leaves no will, or fails to name a representative, or the named representative refuses to serve in that capacity. In any of those cases, the court may appoint an administrator to handle the estate. Duties of the estate representative include: (1) Publishing a notice to creditors of the decedent’s death (2) Conducting an inventory and obtaining an appraisal of the property in the decedent’s estate; (3) Making a report to the probate court of the estate assets and liabilities; and (4) Distributing the proceeds of the estate as the court directs. Note: Listings: Exclusive listings on real property are limited to 90 days. Commissions- Local probate court rules may establish maximum commission rates. If real property is sold through probate court, real estate licensee’s commission is whatever the judge deems reasonable. 32  b. Transfer by Will (Testate) (1) Types of wills (a) Statutory Will- approved form provided for by statute (b) Witnessed Will- more formal, usually created by an attorney (c) Holographic Will- entirely in testator’s handwriting (2) Transfer of real property by will is called a devise (parties- devisor/devisee). (3) Transfer of personal property by will is called a bequest; the property itself is referred to as a legacy (parties- legator/legatee). c. Intestate Succession (1) When a person dies without a will they are said to have died intestate. (2) Distribution of the estate is governed by the Law of Succession when there is no will. (3) A person who receives property under the Law of Succession is an heir. 4. Other Methods of Acquiring Title a. Patent is from sovereign and is the instrument used to transfer title from the government to an individual. b. Accession refers to an increase in the property owned. Man-made or natural additions to property may extend the owner’s title to include those additions. These can occur by the construction of improvements, accretion, or reliction. c. Accretion. Land area can be increased by forces of nature. Accretion is the process by which land adjacent to a flowing body of water accumulates new soil. The buildup of new soil, called alluvion or alluvium, may be so gradual that it is not noticed. d. Reliction. Is an increase of land by the permanent withdrawal of a sea or a river. e. Public dedication. Private land can be transferred for public use or ownership by common-law dedication, statutory dedication, or deed. 33  A common-law dedication occurs when a landowner devotes land to a public use, as when a roadway is opened to public use or described as such in the deeds to adjoining parcels. When the requirements of the Subdivision Map Act are complied with, certain areas will be set aside for public use, such as parks, school grounds, and streets. This statutory dedication generally transfers an easement for the intended public use. f. There are many other means to acquire title, such as Sheriff’s Deed, Marshall’s Deed, Bankruptcy, Equitable Estoppel, etc. B. Public Recording System By State law, each county must have a County Recorder. Primary job of the Recorder, Court, Clerk and any other public information source is to collect and maintain, in a convenient and safe public place, such records for public inspection. 1. Acknowledgement is a formal declaration before a notary public or certain public officials, by the person (grantor) who signed (executed) the instrument (deed) that he or she in fact did execute (sign) the document. Acknowledge acts as a safeguard against forgery and once acknowledged a document is accepted as prima facie (on its face) evidence in court. A deed must be acknowledged to be recorded. Recording permits, rather than requires, the filing of documents that affect title to real property. 2. A notary public (notary) is a licensed public officer who takes or witnesses the acknowledgment. A notary cannot acknowledge any document in which the notary is named a principal. A notary who is an employee of a corporation may notarize a deed involving the corporation so long as he or she does not have a personal interest in the subject matter of the transaction. 3. Any purchaser, lender or other parties of interest may inspect those public records that may disclose information necessary, prior to entering into a transaction. Failure to do so may well affect one’s interest. a. Constructive notice. Recording real estate documents has the effect of charging (notifying) all persons with the knowledge of their existence. Although one may not have personally inspected the record, the law charges (notifies) all persons (the world) with the knowledge of all documents on record. This is referred to as constructive notice and is said to be notice to the world. b. Actual notice. Consists of express information of a fact- inspect property for visible claims. c. Establishes priority of interest – “First in time is first in right”. 34 C. Title Insurance Protects an owner or lender up to a specified amount against specified types of loss pertaining to defective or an unmarketable title. 1. Preliminary Title Report and Commitment a. States current condition of title. b. Lists policy exceptions and exclusions: defects and encumbrances that have been discovered or that may exist and which are not covered by the policy. 2. Standard Coverage Policy California Land Title Association (CLTA) – Limited coverage primarily for owners that insure against losses from: a. Forgery and fraud b. Matters of record c. Improper delivery d. Lack of capacity 3. Extended Coverage Policy American Land Title Association (ALTA) – Additional protection, normally required by lenders, that insures against losses from: a. Unrecorded tax and assessment liens b. Unrecorded mechanic’s liens, easements, or encumbrances c. Water rights and mining claims d. Correct survey showing encroachments e. Rights of parties in possession A physical inspection will be necessary. No policy will insure against all risks, such as government regulations, zoning, building codes, etc. Note: Title insurance premiums are determined by competition of various title insurance firms. Such cost is a non-recurring charge and policy benefits may be passed to heirs in the event original insured were to die. 35 D. Escrow/Closing Statements 1. The deposit of instruments and/or funds with a neutral third party, who has been instructed to carry out the provisions of an agreement or contract. The purpose of an escrow is to make sure that the conditions of transfer are met prior to closing. 2. If escrow instructions contain terms in conflict with the original contract, the escrow instructions will usually prevail. 3. Escrow agents act as agents for principals. They are dual agents for both buyer and seller until the close of escrow. After close, they may become the separate agent of either party. 4. When escrow instructions are “executed” by both buyer and seller, it means they are signed. When escrow instructions are “executed” by an escrow agent, they have been fulfilled. 5. Escrow instructions are not usually notarized or recorded. 6. The real estate broker is responsible for delivering the termite report to the buyer, but in practice, this task is usually performed by the escrow. When a termite report recommends preventative work, the buyer usually pays for the work. Should report call for curative work, the seller usually will pay for this work. 7. If the escrow officer receives two conflicting reports (one from seller’s company and the other from buyer’s company), escrow officer should submit both reports to buyer and seller and let them decide which report to use. 8. Escrow officers are usually authorized to call for the funding of the buyer’s loan. 9. Escrow is responsible for reporting the sale to the IRS. 10. Buyer and seller can authorize escrow agent by written agreement to change the terms of the escrow, e.g., change the terms of the financing. These changes can be made without the broker’s approval. Only parties to escrow can amend the escrow instructions. 11. Completion of Escrow – Closed 12. Perfect escrow – all has been done, just waiting for closing date. 13. The selling price appears as a debit on the buyer’s closing statement. The “recurring costs” mentioned in the closing statement would include “impounds”. 14. Resolution of disputes – Escrow agents can only release funds upon: a. Agreement between parties; 36  b. Court order – interpleader action; c. Arbitration decision. Closing Statements A detailed accounting of each party’s debits and credits (amounts paid and received) 1. Proration a. A calculation on a closing statement that results in buyers and sellers paying only their respective shares of property expenses. b. Prorations are based on a 30-day month and a 360-day year unless escrow is instructed otherwise. c. The day that escrow closes is normally charged to the buyer. d. Likely to be prorated: (1) Taxes, most of the time (2) Rent, if it is income property e. Unlikely to be prorated: Insurance- Buyer will purchase new policy. If the term of seller’s insurance is not complete, insurer may charge “short rate”. (Example: if full year’s policy was $1,000, but policy is cancelled after 6 months, short rate might be $650 for the half-year) 37  2. Proration Method a. Establish date for Close of Escrow (COE) and Date Item is paid to (DI) and compute the time differential. b. Determine the monthly cost of the item. c. Multiply the monthly cost by the differential… If DI is before COE, the seller owes the buyer. If DI is after COE, the buyer owes the seller. E. Tax Aspects of Real Property 1. Property Tax An “ad valorem” tax (according to value). Real and tangible personal property is subject to taxation; intangible personal property is not. a. County Tax Assessors – Assess the value of all taxable property in the county every year. The annual assessment is then published in the “assessment roll”. b. The County Board of Supervisors then determines the tax rate which is limited to 1% of assessed value (taxable value, full cash value), plus an amount to cover existing bond debt. c. County Tax Assessor calculates the amount of tax each property owner must pay. These calculations are sent to the Tax Collector who prepares the tax bill. The tax bill assesses land and improvements separately, but they are taxed at one tax rate. d. Assessment Appeals Board – hears appeals of property owners who believe they have been over assessed. e. Tax Calendar – Remember: No Darn Fooling Around (1) January 1st that preceeds the tax year is the lien date. (2) Fiscal Year: July 1st through June 30th, or July 1st to July 1st. (3) November 1st – first installment due; December 10th – first installment delinquent. (4) February 1st – second installment due; April 10th – second installment delinquent. 38  (5) June 30th – starts the running of the five-year redemption period. If the property taxes are unpaid, the property “sold to the state. However, the owner remains in possession of the property and can redeem it during the next five years by paying back all taxes (plus interest and penalties). f. Exemptions (1) Homeowners $7000 off the assessed value as long as the home is occupied by the claimant. (2) Veterans $4000 off the assessed value but cannot be combined homeowners exemption. g. Delinquency (1) If taxes are not paid as of April 10th, a 10% penalty is charged. (2) If taxes are not paid by June 30th, the property is declared in default and costs are added and interest is charged from the beginning of the tax year, July 1st. (3) The tax defaulted property is subject to a right of redemption. (4) Public Auction (a) If the taxes are not paid for five years, the tax collector publishes a Notice of Intent to Sell. (b) Then the tax collector sells the property for the state at a public auction and issues a tax deed to the successful bidder. (c) Title given is free of all private liens. 2. Special Assessments a. The Improvement Act of 1911 is utilized more than any other act. Each owner is billed a prorated share based on the cost per running foot of the improvement multiplied by the footage of the property to the improvement. The owner had 30 days from day notification of cost is mailed to pay this bill. If not paid when billed, the balance “goes to bond” which is a lien on the owner’s property. This new lien is on parity with and equal to property tax liens. 39 40  b. Supplemental Assessments Upon ownership transfer, Proposition 13 creates a reassessment event and requires all ownership changes be reported to the tax assessor or the 3. County Documentary Transfer Tax a. A county real estate tax paid on most real estate transfers at recording. Some cities add on their own transfer tax. b. Paid on the seller’s account but is usually paid by both the buyer and seller or as otherwise agreed upon in escrow. c. It is paid on equity transferred – the total purchase price less any existing assumed loans at $.55 per $500.00 or fraction thereof. d. If a buyer obtained new financing in order to buy the property, the documentary transfer tax will be based on the full sales price. e. At this time there is no sales tax on the sale of real property. 4. Income Tax It is considered a progressive tax in that as taxable income increases, the additional amounts of income are taxed at an increasingly higher rate. The best example of a straight tax would be sales tax. a. Marginal Tax Rate The marginal tax rate is the bracketed rate paid on the next dollar earned. b. Effective Tax Rate The effective tax rate is the overall rate that the taxpayer pays on all taxable income. It is the total tax paid divided by the total taxable income. 41  c. Ordinary Income (1) Income from wages, commissions, business profits and interests (2) Income representing a profit from real estate (rent) is ordinary income if received while the property is owned. (3) Does not include capital gains. d. Ordinary Losses Are net-operating losses from real estate that are suffered while the property is owned. e. Capital Gains (1) Profits that result from the sale, exchange, or other disposition of assets. (2) Every investor is concerned about two things: (a) Return of their investment – when an investor sells property, he or she first looks for a return of, or: (b) Recapture of their investments. (c) Capital gains are the income or profit from the sale of real estate with the exception of dealer property. f. Capital Losses With only a few exceptions, capital losses result when an owner sells, exchanges, or otherwise disposes of assets for less than he paid for them. Capital losses are fully deductible against capital gains. g. Tax Deferment Methods Generally speaking, gains are subject to income tax in the year in which they occur. However, in some situations the IRS will allow the recognition of capital gains to be deferred into the future. Examples include installment sales and Section 1031 exchanges. (1) Installment Sale A method of reporting gains for income tax purposes when the sales price is being paid in one or more installments, such as with promissory note, or a lump sum is being paid in a tax year after the year of sale. (2) Tax deferred Exchanges (Section 1031) 42  (a) An exchange of eligible real properties which allows deferring (postponing) income tax on potential gain. Often called tax-free; but more accurately termed tax-deferred. Usually, at least one party realizes a taxable gain. (b) Must be an exchange of eligible real property which is called like kind property which under 1031 means any combination of the following three properties. Held for investment, including vacant land Held for the production of income Used in an owner’s trade or business (c) Boot – is the extra received or given in a trade, which is not or like kind, and is either: Cash or Equivalent – such as personal property, or a note taken back form the other party (d) Mortgage Relief – which means taking over a smaller loan than the existing one. The owner would owe less debt, and would be considered to be receiving the difference as boot, which is always taxable. h. Homeowner’s Tax Advantage (1) Personal Residences (a) For most considerations, there is no limit to the number of personal residences a taxpayer can own. (b) A taxpayer can deduct mortgage interest payments on only two personal residences. (c) A principal’s residence is the home address from which the taxpayer votes, obtains a driver’s license, filed his IRS return or claims to be his domicile. (d) A taxpayer can only have one principal residence at a time. 43  (2) Exclusion on Sale of Principal Residence (a) Since May 7, 1997, a single taxpayer may exclude up to $250,000 and married persons filing jointly may exclude up to $500,000 of the capital gain on the sale of their principal residence. (b) This exclusion is allowable each time a taxpayer sells his or her principal residence but cannot be done more than once every two years. (c) A taxpayer must have owned and lived in the home as a principal residence for at least two of the five years prior to the sale. (3) Personal Income Tax Deductions (a) Real Property Tax Deductions Real property taxes paid on personal residence are an allowable expense on personal tax returns. (b) Interest deductions Home Mortgage Interest – deductible (with limitations) on first and second mortgages (including home equity lines of credit) on first and second homes. (c) Financing Deductions Purchase Money Loan – interest is deductible when paid. Discount Points – are additional interest charges generally imposed by a lender as a one-time upfront charge in lieu of a higher interest rate. If paid by the borrower, treats as prepaid interest. If paid by a seller (as used to be common on a GI loan) they are an expense of selling, not interest-event though the lender would report them as interest. Loan Origination Fee – is a fee for setting up the loan records and files. Refinancing – interest must be deducted in the year paid. Prepayment penalty – is deducted as the interest in the year paid. 44 5. Report to IRS of Transfers All real estate transactions must be reported to the IRS. The primary reporting responsibility falls on the person responsible for closing the transaction, who is usually the escrow agent if there is one. If there is no person responsible for performing the closing transaction, the following persons are responsible in the following order: a. Primary Mortgage Lender b. Seller’s Broker c. Buyer’s Broker Copies of Form 1099 must be sent to the IRS, the seller, and the buyer. 6. FIRPTA and CAL FIRPTA Under the Foreign Investment in Real Property Tax Act – FIRPTA, every buyer of U.S. real property – through the escrow agent – must, unless an exemption applies, deduct and withhold from the seller’s proceeds 10% of the gross sales price. Under CAL FIRPTA, people selling property in California who are not residents of the state, will be charged an additional 3.33%. The stated percentage may change and will not be a question on the State Exam. 45  CHAPTER 3 Contracts in Real Estate A. Contracts in General 1. Requirements for a contract to be valid and enforceable consist of four elements (Memory aid: CoCa CoLa) a. Mutual Consent - The parties must agree to do the same thing, have a “meeting of the minds”. Buyer’s (offeror’s) offer to purchase must be accepted by seller (offeree) and communication of acceptance must be provided to buyer before buyer revokes (takes back) the offer. b. Capacity – Parties must be capable of contracting, not be minors or incompetents. An emancipated minor may enter into a contract. c. Consideration – usually a promise to pay money, but could be a promise to refrain from doing an act. It even could be love and affection. “Adequate”, “good”, “sufficient” or “valuable” are terms used in denoting of acceptance consideration. Forbearance, or forgiving a debt or obligation, or giving up an interest or a right qualifies as valuable consideration. Gifts such as real property based solely on love and affection are “good consideration”. They meet the legal requirement that consideration be present in a contract. d. Lawful – The agreement cannot provide for matters that are illegal. Even though the parties are capable, and mutually agreeable, the object of the contract must be lawful. A contract requiring the performance of an illegal act would not be valid, nor would one where the consideration was stolen. The contract also must be legal in its formation and operation. For example, a note bearing an interest rate in excess of that allowed by law would be void. Contracts contrary to good morals and general public policy are also unenforceable. 2. Status of Contracts A. Valid – meets all the legal requirements previously described in “Requirements” (CoCa CoLa). B. Voidable – one or more of requirements are defective, such as the lack of mutual consent (menace, duress or undue influence). Action to set aside the contract must be taken by the injured party in a time period as specified by the Statute of Limitations. c. Void – lacks one or more of the essentials of a valid contract – no legal effect. 46 Note: Penalties for Fraud A contract induced by fraud is voidable by the injured party. Action must be taken within a reasonable time after the fraud is discovered, as specified by the Statute of Limitations. The injured party may also seek money damages, including punitive damages. A criminal prosecution may be brought against the person who committed the fraud, resulting in a fine and/or imprisonment. A real estate agent who takes part in fraud may suffer loss or suspension of their real estate license in addition to the penalties mentioned above. d. Unenforceable – a contract that fulfills all essential elements, but due to the following laws will not be enforced by the courts: (1) Statute of Limitations Sets forth the amount of time the non-breaching party has in which to take legal action against the breaching party: Breach of oral contracts – 2 years Fraud – 3 years from date of discovery Encroachments/Trespass – 3 years Breach of written contracts – 4 years Lawsuits to recover title – 5 years Court judgments – 10 years Based on the legal doctrine of laches that prevents the assertion of a claim because of undue delay or failure to assert a claim. (2) Statute of Frauds Requires certain contracts to be in writing and signed to be enforceable: Applies to any transfer of interest in real property with the exception of leases for 12 months or less. 47  (3) Creation of a Contract Express and Implied Contracts - An express contract is a contract of words established by an oral or written agreement in which the parties declare their intention to make a contract. - An implied contract is established by the conduct of the parties, without a specific oral or written agreement. Bilateral and Unilateral Contracts - In a bilateral contract, both parties make a promise to do something or to refrain from doing something and both are obligated to perform. - In a unilateral contract, only one party promises, and only that party is obligated to perform. The promise is accepted by the performance of the other party. (4) Performance and Discharge Executed/Executory Contract An executed contract is one which has been fully performed. An executory contract is one which has not yet been performed. For instance, an agreement to buy or sell real estate is an executory contract; and when the sale is completed, it is an executed contract. The word “executed” has a dual meaning, applying both to a contract that has been signed and to one that has been performed. In both instances, executed means that something has been done. In the first instance the thing done was the entering into or signing of the contract. In the second instance the thing done was the carrying out or performance of the terms of the contract. Amendment Changes agreed by both parties to the original contract must be in writing and signed by the parties in the contract. Addendum Is an addition to a contract which all parties agree to by signing or initialing. Novation Is the substitution of one agreement for another agreement. 48  Legal Impossibility A duty required by the contract which cannot be legally performed. Mutual Rescission The return of all parties to the position they held prior to the signing of the contract. (5) Remedies for Breach When a party to a contract fails to perform as agreed, that person has breached the contact, and the other party may sue for damages for breach of contract. If the circumstances are such that the contract can still be performed by the person who broke it, the injured party may bring suit for specific performance. This means that the Court may order the defaulting party to perform specifically as promised - to do that which under the terms of the contract the party agreed to do. Special circumstances are required to be met by the injured party in order to successfully pursue a suit for specific performance. A liquidated damages clause in a written contract provides that if the contract is broken by one of the parties, that party will owe the other (innocent) party a definite stated sum of money. (6) Additional Notes on Contracts a. Oral Contracts An unwritten agreement is also known as an oral or parol contract. It is not always required that a contract be in writing. Many kinds of oral contracts are legally enforceable if the understanding can be proved to the satisfaction of the Court or jury. Proof would rest on the testimony of witnesses or, if there are no witnesses, the testimony of the parties to the contract. It would then be a question of which testifying party the Court or jury believes to be truthful. In California, contracts executed (entered into) on Sundays and legal holidays are just as valid as those made on regular business days. Except for contracts in which time is of the essence, such as a listing or a deposit receipt, the performance of contracts ending on a Sunday or legal holiday is usually extended through the next business day. Mental incompetent individuals – once the court rules that an individual is mentally incompetent, he/she loses the right to enter into a contract. Tender of performance is not essential to the formation of a contract. Remember, “CoCa CoLa”. 49  Some oral real estate contracts are enforceable, such as: A lease of real property for one year or less; A listing contract to sell personal property (business opportunity); An agreement between brokers to share a commission; A seller may sue a broker who fails to keep an oral promise B. Types of Real Estate Contracts 1. Listings a. Exclusive Authorization and Rights to Sell Listing – a contract in which the owner agrees to sell through the listing broker only. If the property is sold by anyone during the term of the listing (listing broker, another broker, the owner, or any other source), the listing broker is entitled to the commission, best for an agent to earn a commission. b. Exclusive Agency Listing – contract in which the seller agrees to pay a commission to the listing agent if the property sells through any agent, but seller retains the right to sell directly to a buyer and pay no commission. A seller who gave an exclusive agency listing to one broker and an open listing to a second broker would be liable for two commissions if the second broker sold the property. c. Open Listing (Nonexclusive Listing) – a contract given by the owner authorizing the broker to act as his agent. Broker must be the “procuring cause” responsible for the consummation of the transaction to be entitled to a commission. d. Net Listing (1) A net listing may be an open, exclusive right to sell or exclusive agency listing. (2) This listing permits the agent to retain as compensation all money received in excess of the net price set by the seller. (3) Real Estate Law requires that the broker disclose to the seller the amount of his compensation prior to the time the owner binds himself to the sale transaction. Failure of the agent to do so can result in the suspension or revocation of the agent’s real estate license. 2. General Listing Information 50  a. An exclusive listing must have a definite termination date determined by mutual agreement between seller and listing agent. b. When a broker takes an exclusive right to sell listing, he/she is obligated to use “due diligence” to procure a buyer. This would include an obligation to advertise the property. c. The typical listing authorizes the broker to accept a deposit as the seller’s agent. If the broker is not authorized to receive a deposit, but receives one anyway, he is treated as the buyer’s agent for that one act. d. If a seller wants to pay a commission to a broker under an oral listing, it is permissible for the real estate broker to accept the commission. e. Broker’s safety clause is contained in the Exclusive Authorization and Right to sell listing agreement. This stipulates that the listing agent will earn the commission specified in the agreements if a person to whom the property has been shown purchases the property within the listing period, provided that: (1) Broker has given seller a written notice of the names of such prospective buyers. This must be done immediately upon expiration of listing. f. A listing is a personal service contract. As such, it is non-assignable. g. The five basic requirements of a bona fide listing are: seller’s signature, agent’s/broker’s signature, terms and conditions of sale, address of the property and compensation of the broker/agent. h. An enforceable contract to split commissions between brokers can be entered into orally. If the listing broker is paid the commission but refuses to pay the selling broker according to his promise, the selling broker can sue for his commission in civil court. The DRE does not get involved in commission disputes. The act of the listing broker would not be one which would cause the district attorney to try the offender in a criminal court. h. Listings always belong to the broker under which the salesperson is licensed. As to the amount of commission a salesperson may receive, this is covered in the written agreement of employment between employing broker and salesperson. This agreement is required by Commission’s Regulations. 51 3. Purchase Agreement a. When the form is completed and signed by the offeror (buyer), it constitutes an offer. It is not a contract until it also has been executed by the seller and information concerning the offeree’s (seller’s) acceptance has been communicated to the offeror. b. The form provides the time the seller has to respond to the offer and to whom notice of the seller’s acceptance should be transmitted. (1) If the seller’s response is not received by the person designated to receive it within the time limit specified on the offer, the offer is deemed to be revoked. Under these circumstances, the buyer’s deposit shall be returned. (2) The buyer (offeror) can withdraw his offer any time prior to the seller’s acceptance having been conveyed in the manner specified. c. An offer terminates when: (1) Buyer withdraws the offer prior to its acceptance. The buyer may withdraw for any reason and receive his deposit back. (2) Seller rejects offer. A counteroffer automatically terminates the original offer. (3) Buyer dies before the seller has accepted the offer. (4) Time limit given in the offer for accepting expires. d. “Time is of the essence” is phrase included in an offer to purchase real property (the deposit receipt) that limits the time the parties have to perform certain acts (e.g. accept the offer, deposit funds, etc.) e. The form provides that, unless exempt, the transferor (seller) must provide the buyer with a Real Estate Transfer Disclosure Statement. Arbitration Clause – This clause is part of the contract only if the buyers and sellers have initialed in the space provided. By initialing the clause the parties agree that they will resolve any differences that they may have arising out of the contract, or any resulting transaction by a neutral binding arbitration proceeding rather than suing the other party in a court of law. When a buyer wants to rescind the contract and get his deposit back if the parties did not initial the “Arbitration Clause”, the buyer’s remedy is to file a court action. 52  f. Agency Confirmation. This is a three step process (as described in detail in the chapter discussing Law of Agency) in the requirement of agency relationship. The steps are: Disclose --- Elect --- Confirm In preparing the offer the buyer indicates the agency relationships that he/she understands pertain, or that he/she