Legal/Legislative Update – November 1, 2013

Published on: October 31, 2013

TAXING DISTINCTIONS. The IRS has adopted new regulations outlining the tax treatment of real estate improvements and “repairs” for business and rental properties. Although the regs answer many long-standing questions about the distinction between repairs and improvements, the answers may not be entirely welcome. The bottom line appears to be: More expenses will be classified as improvements, which must be depreciated, rather than as repairs, which can be deducted.

IMAGE PROBLEM. Congress ranked below witches, hemorrhoids and cockroaches in a recent popularity poll. 10-8-13

FLOOD FIX. Rep. Maxine Waters (D-CA) has introduced a bipartisan measure aimed at fixing the “unintended consequences” of the Biggert-Waters Flood Insurance Reform law. The main concern: Massive increases in flood insurance premium rates. The law mandated the increases to stabilize FEMA’s shaky finances, but it has created payment shock for homeowners and infuriated members of Congress, even though they approved the reform legislation.

YES AND NO. Two recent headlines in the American Banker provide some perspective on the prospects for restructuring Fannie Mae and Freddie Mac. The first: “Senators Pressing Ahead on GSE Bill This Fall.” The second: “House Leadership Puts GSE Reform on Backburner.”

NO CONFIDENCE. New home sales and starts are rising but builders aren’t hiring more construction workers to keep up with demand. The problem, according to the Wall Street Journal is confidence. Builders don’t have enough of it.

WRONG ANSWER? Analysts are blaming the government shutdown (or anticipation of it) for the anemic September employment report. But the employment picture was far from robust before. 10-22-13

 

LEGAL BRIEFS

 

GOING TOO FAR. Condominium boards can do many things under their general rule-making authority, but amending the by-laws and covenants isn’t among them. Owners – and usually a super-majority of them – must approve those changes. This requirement is so fundamental, it’s hard to imagine that any boards wouldn’t be aware of it. But two recent decisions indicate that board members may not be as conscious as they should be of the limits on their rule-making authority. Both cases involved board rules restricting the rental of units in their communities.

In Kephart v. Northbay Property Owners’ Association, the Mississippi Court of Appeals ruled that the board could not enforce a rule prohibiting all leases in the community, when the covenants contained no such restriction. “While the Board has the power to enact rules and regulations, those rules cannot involve rights that may be exercised only by or are reserved only to the Members,” the court held. And prohibiting rentals would be an amendment, requiring owner approval, the court said, not a rule the board could enact on its own.

A Washington state appeals court reached the same conclusion in a somewhat more complicated case (Kawawaki v. Academy Square Condominium Association). When the Kawawaki’s purchased their unit, they were aware that the covenants restricted rentals to 25 percent of the units in the community. They were also aware that the cap had been reached and that their unit would be placed on a “first-come-first-served” waiting list. But two years later, the board approved a rule under which a unit’s rental status would be maintained when the unit was sold. In other words, the purchaser of a rental unit could rent it immediately instead of going to the end of the rental queue.

The Kawawaki’s, were at the top of the rental list when a rental unit was sold – to a member of the board, as it turned out. When, thinking it was their turn, they rented their unit, the board sought to enforce the rental cap and fined them for violating it. The Kawasaki’s sued, arguing that the change in rental priority constituted a change in use for which they did not have prior notice, because it was not included in the covenants. Moreover, they said, the board approved the change illegally, because it required owner approval. The board countered that the rule they had enacted was a reasonable means of implementing the use restriction contained in the declaration.

The court addressed two questions: Did the board have the authority to make the change and was the rule the board adopted reasonable? The court’s answer to both questions was no. On the first point, the court said the board’s rule did not simply interpret an existing use restriction; it created a new one, which the board lacked the authority to do.

Addressing the second point, the court said, even if the board had properly issued the rule, it would still have failed because it was not reasonable in purpose – that is, it was not related to the board’s primary responsibility to promote the health and welfare of owners; nor was it reasonable in application, because it was applied selectively, benefiting some owners (those currently renting their units) to the detriment of others.

“The [rule’s sole] purpose was to protect the value of the original nine rental units for the benefit of the original nine owners and to ratify the actions of [the board member who bought a unit and bypassed the waiting list],” the court said. And its impact was “to deny those on the waiting list their expected rental investment opportunity, [while allowing] new purchasers of rental units to immediately benefit from their investment.”

 

WORTH QUOTING: “The most truly unacceptable legacy of the market collapse is the legacy of the irrational restriction and contraction of credit that we have today….Fear and not fact is making credit tighter than it should be….If this legacy persists the consequences will be more profound for the country than the economic losses” [caused by the bust].” ― Lewis Ranieri, creator of mortgage-backed bonds, speaking at the Mortgage Bankers Association’s annual conference.