Legal Tips for Minnesota Real Estate Investors

These days, I am working with a lot of new real estate investors who are looking to buy properties while the market is at or near the bottom.  Real estate investment, however, is fraught with issues that, without sound legal advice, could spell big problems for the investor.  Here’s some legal “food for thought” for prospective real estate investors.

1. Be Careful When Buying Redemption Rights.  In Minnesota, when a property is sold at a sheriff’s foreclosure sale, the high bidder takes title subject to the owner’s right to redeem (other states provide for pre-sale redemption rights).  Hence, one strategy for investors is to “buy” the owner’s redemption rights.  Be careful, though, if there are junior mortgages, mechanics liens, judgment liens and the like.  Minnesota law provides that if the owner redeems after a foreclosure, the owner then owns the property subject to any junior liens.  So, if the owner has a first and second mortgage, an investor who redeems in the owner’s place will take subject to the second mortgage, which means that any strategy of shedding the second mortgage lien from the property will be frustrated.

2. Whenever Possible, Own Your Investment Property Through a Limited Liability Company.  Single member limited liability companies are amazing things; you can limit your personal liability for obligations of the limited liability company (also called an “LLC”) but yet no separate tax return is required for the LLC.  This is due to the fact that a single member LLC is, in the eyes of the IRS, a “disregarded entity”; simply put, the profits and losses of the LLC are reported in the owner’s individual income tax return.  I tell prospective investors that purchasing their properties through LLCs is a “no-brainer.”  At a minimum, investors should form at least one LLC to own their investment real estate.  A stronger position from the standpoint of asset protection, though, is to own each investment property in a separate LLC; this structure compartmentalizes liability for a particular property within that single LLC without exposing the other properties/LLCs to such liability. 

3. If You Are Going to Use IRA Funds to Invest, Consult Your Advisors.  I’ve written before in this blog about self-directed IRAs and their usefulness in funding a new business.  The most common use of this financing mechanism is actually investment real estate.  That being said, there are a lot of rules that come with this financing strategy and consultation with your attorney, your CPA and your financial advisor is imperative.  In particular, you need to review your proposed business operation with your attorney to ensure that you are not violating the self-dealing restrictions set forth in the IRS’s regulations for IRAs .  I work with 1-2 investors per week right now using this strategy and very often I help my client rearrange his/her structure to avoid a self-dealing transaction.

4. Be Mindful of Local Rental Licensing Requirements and Fees.  Most cities in Minnesota require a landlord to hold a rental license in order to legally collect rent, and the lack of a license can be a defense in an eviction action for nonpayment.  If you’re going to rent your property as part of your real estate investment strategy, make sure that you contact the city where the property is located and obtain proper licenses.  Some cities are tougher than others on landlords.  For example, the City of Minneapolis recently enacted a “rental conversion fee”  that charges a landlord a one-time fee of $1,000.00 upon the conversion of a single family home to rental real estate (in other words, the City of Minneapolis is trying to discourage investors from buying its available housing stock). 

5. Don’t Count on a “Quick Flip”.  Some investors I deal with do not intend on setting up a rental operation.  Instead, these investors buy properties in need of some TLC, spend some money to fix these properties up and then quickly sell them to someone else, be they investors or home buyers.  If this is your strategy, you need to be mindful of the FHA’s “seasoning rule”  which requires the seller of real property being financed by an FHA-insured mortgage to have owned the property for at least 90 days.  Therefore, if the end-buyer is seeking an FHA-insured mortgage (which constitutes a majority of real estate mortgages these days), the investor is going to have to hold the property a bit longer than if he/she was selling to a cash buyer.  Note, though, that this requirement has been suspended temporarily for sales to first time home buyers.

The aforementioned legal issues can pose problems for an unsuspecting real estate investor, but working with a competent attorney can help minimize the investor’s expose to these and other legal issues.