This article is an update on the recent actions at the federal level related to cannabis. The intersection of state legalization and federal criminalization has been a difficult road for businesses, real estate professionals, and investors to navigate. Contracts have become more complicated, disclosures more nuanced (is cannabis cultivation a material defect that must be disclosed) leases more difficult, administrative oversight more burdensome as the all of these sectors work through the difficulties of an emerging market place.
The intersection of the competing legal schemes played itself out concerted fashion when the Feds raided and seized nearly 100 homes in the Sacramento metro area in April in a marijuana cultivation bust. Clear evidence that civil forfeiture was a very real penalty that the Feds will use. Many of those properties are working through the federal legal system under a civil forfeiture action.
As more and more states have taken steps to legalize cannabis in some form or another, it has created problems for investors, owners, real estate professionals and businesses. While the state seeks to collect the tax revenue from the market place, how are the payments for mortgages, leases and taxes to be made when federal law does not allow for the deposit of funds related to drug activity in to a deposit account with a federally chartered bank. It has made the practical functions of operating a cannabis business nearly impossible to carry out.
However, there may be significant changes to the cannabis industry on the way. On June 27, 2018 Senator Schumer introduced the “Marijuana Freedom and Opportunity Act” (“MFOA”). This bill takes a very moderate position with respect to the legalization of cannabis at the federal level. While the bill, if enacted, would decriminalize cannabis, it would also leave in place each state’s ability to determine whether cannabis would be legal or illegal at the state level. Further, federal law enforcement would be able to prosecute crimes related to the transportation or distribution of cannabis when such actions cross state lines and take place in a state where cannabis is illegal at the state level.
Moreover, if the bill is passed in its current form it frees up many of the business and real estate related concerns. Property would no-longer be subject to civil forfeiture. Banks would be allowed to accept deposits from funds sourced through legal cannabis businesses or legal cannabis transactions. Leases would not suffer from the real risk of a court applying incorrect law related to illegal activity. Conventional financing would free up for the purchase of cannabis related real estate. Title companies would readily insure and close transactions related to cannabis businesses or previously used in a cannabis business.
Further, the bill also provides financial incentives to encourage the growth of small cannabis related businesses by allocating a minimum of $10 million to a trust fund to be made available for small businesses owned and operated by women and economically disadvantaged individuals. It allocates up to $250 million for highway safety research over the next five years related to THC impaired driving. The MFOA also authorizes up to $500 million for public health and medical research related to medicinal qualities of cannabis and creates a regulatory scheme for federal agencies to regulate advertisements and prohibit promotion to individuals under the age of 18 much like is already done with tobacco products.
The bill has a long way to go and who knows what will happen when the bill gets to the House of Representatives. But this bill appears to be written in format that can appeal to the masses and has something for everyone. If this bill does indeed pass it will pave the way for stabilizing at a national level the cannabis industry, normalizing certain real estate transactions and allowing for the free flow of commerce within the cannabis industry.
The Internal Revenue Service has issued final rules on the 20 percent business income deduction (Sec. 199A of the Tax Code) that was enacted in late 2017 as part of the Tax Cuts and Jobs Act.
Among other things, the rules confirm that the deduction applies to your business income, as a real estate agent or broker, if you operate as a sole proprietor or owner of a partnership, S corporation, or limited liability company. It applies even if your income exceeds a threshold set in the law of $157,500 for single filers and $315,000 for joint filers.
In addition, the rules provide guidance that NAR has been seeking on two other provisions of importance to you: 1) whether any real estate rental income you have is eligible for the deduction, and 2) how the deduction applies to properties you've exchanged under Sec. 1031 of the tax code.
Eligibility of rental income
If you generate rental property income, that income can also qualify for the new deduction, as long as you can show that your rental operation is part of a trade or business. The IRS has released proposed guidelines that include a bright-line test, or safe harbor, for showing that your rental income rises to the level of a trade or business. Under that safe harbor, you can claim the deduction if your rental activities—which include maintaining and repairing property, collecting rent, paying expenses, and conducting other typical landlord activities—total at least 250 hours a year. If your activity totals less than that, you can still try to take the deduction, but you'll have to be prepared to show the IRS that your activity is part of a trade or business.
Eligibility of 1031 like-kind exchanges
Under earlier proposed regulations, if your income was above threshold levels set in the tax law—$157,500 for single filers, $315,000, for joint filers—and you had exchanged one property for another to defer taxes under Sec. 1031 of the tax code, the amount of the new deduction might be reduced because of the swap. NAR and other trade groups reached out to the IRS to change this treatment, and the IRS has made that change. Under the final rules, you can use the unadjusted basis of the depreciable portion of the property to claim at least a partial deduction.
"The final rules are the result of several months of advocacy and collaboration between NAR, our members, and the administration," says NAR President John Smaby. "They reflect many changes that NAR sought to ensure the new 20 percent deduction applies as broadly as possible."
1. Question: I have a maintenance worker who was terminated and was given seven days to vacate his apartment. He has not left, and I would like to know if I need to send him through the eviction process or if there is anything else I can do to get him out.
Answer: You need to send him through the eviction process. If he was purely an employee, and not paying rent, you can immediately file the unlawful detainer action.
2. Question: Is it illegal for an owner to charge for his own labor (as long as it is the going rate for that type of work) and deduct that amount from the tenant’s security deposit?
Answer: It is not illegal to deduct for your own labor from the tenant’s security deposit. You can charge a reasonable hourly rate and must state the time and rate in your security deposit disposition statement.
3. Question: Our tenants have just informed us via telephone that their rent check will bounce, they don’t plan to cover it, and they intend to vacate the premises by the end of this month. They want us to use the majority of their security deposit as last month’s rent. If we don’t give a 3-day notice to pay or quit and proceed with an eviction, are we leaving ourselves more vulnerable?
Answer: If you do not proceed with a 3-day notice followed up by an eviction, you could find that the tenants decide to change their minds and not move out after all, prolonging their time in possession without paying rent. The extra “motivation” is often worthwhile. In addition, the eviction will also give you a judgment for rent owed, plus court costs and if you have an attorney fee clause in your lease, attorney fees.
4. Question: I served a 60-day notice of termination because I am going to sell my home. Since then, one of the two residents moved out and is asking for his half of the security deposit. Am I responsible to return the security deposit before the second person moves out?
Answer: The security deposit is normally not returned until the owner recovers possession. The tenant who vacates should work that out with the tenant who remains. It is not the responsibility of the landlord to account for the deposit until he or she recovers possession.
5. Question: Do I have to pay a tenant interest on his security deposit?
Answer: There are no state laws requiring that interest be paid on the tenant’s security deposit. However, some rent control ordinances and/or other local ordinances do require interest to be paid.
6. Question: We served a 3-day notice to pay rent or quit. What is the latest date we could start an unlawful detainer without our 3-day notice “becoming stale” and having to be re-served?
Answer: It depends on the facts of any given case, but the longer you wait, the more of an argument you are giving the tenant.
7. Question: There is a very loud tenant in the apartment building across the alley from our rental. I have asked them to quiet down on numerous occasions and have even called the police. They keep playing their music late at night and into the wee hours of the morning. What else can we do?
Answer: You should continue to contact the police when unreasonable disturbances occur and consider contacting the owner of the property to inform him or her of the situation. The owner may not be aware of the problem.
8. Question: After a lease expires and it is month-to-month, how much notice must a tenant give me in order to legally terminate the lease? He says one week. Is this true?
Answer: In California, 30-days written notice is required to terminate a month-to-month tenancy and can be served by either party at any time during the tenancy. If the occupants have been in possession for one year or longer, the landlord must serve a 60-day notice.
9. Question: Someone told me that if a resident is committing a crime on the premises they can be evicted in 3 days. I have never heard of this law and I rent to someone I suspect is dealing in drugs. Can you tell me more about it?
Answer: California law does allow an owner or manager of rental property to serve a 3-day notice to quit the premises based upon the commission of an illegal act on the property. The illegal conduct must, however, relate to the rented property. For instance, if you can prove your tenant was dealing with or possessed illegal drugs on the premises, you could serve the 3-day notice. If the tenant failed to quit, an unlawful detainer action could be filed in court to recover possession.
10. Question: One of our tenant's guests broke a window of the recreation room by throwing a ball through it. The host tenant claims he should not be responsible because the damage occurred outside the apartment and while they were playing catch in the common area. My tenant also refuses to give me the name or any information about his guest who caused the damage. What can I do?
Answer: In California, tenants are liable for the negligence of their guests while on the premises. The premise not only includes the actual rented unit, but the common area as well. Therefore the tenant and the tenant's guest are jointly liable for the damage to the window.
11. Question: I have a tenant who is on a long term lease. Recently, however, the tenant brought in a roommate and has been out of town for over 30 days. I am concerned that the roommate intends on staying and that my original tenant may have moved out for good. What are my legal options?
Answer: If you have a clause in your lease which prohibits the assignment or sublet of your lease agreement, you do not have to consent to the roommate. You could ask the roommate to fill out an application to rent and thereby identify who the roommate is. Once identified, you could choose to either allow the roommate to live there if he meets your qualifications, and sign the lease or start eviction procedures based upon the breach of the assignment and sublet clause of your lease.
12. Question: My great grandfather died last year and left me his home. I am trying to rent the house and my realtor told me that I am required to inform prospective tenants of the death of my great grandfather because he died in the home. Is this really true? If so, what is the purpose of this crazy law?
Answer: In California, cautious residential landlords should disclose in writing all deaths occurring on the property in the previous three years.
13. Question: I want to rent out our condominium (we are buying a new house) and I need to know how much I can charge for a security deposit. Can I also charge a cleaning, pet and key deposit?
Answer: California law limits the amount of a residential security deposit to twice the amount of the monthly rent if unfurnished, or three times the amount of the monthly rent if the property is furnished, an additional 1⁄2 month’s rent for a waterbed or other water-filled furniture. All deposits, taken together, cannot exceed these limits.
14. Question: The lease for one of my tenants expires at the end of this month. He told me to take the month's rent out of his security deposit because he would leave the apartment clean and in good repair. He told me since it is his deposit, he has the right to deduct rent out of the deposit. What should I do?
Answer: No, the tenant does not have the right to deduct rent from the security deposit. If the tenant fails to pay rent, a 3-day notice to pay rent or quit may be served. If the tenant fails to comply, an eviction may commence to produce a judgment for possession and monetary losses.
This is for general information purposes only. Laws may have changed since this was published. © 2019 Kimball, Tirey and St. John LLP
1. Question: If we serve a three-day notice and the tenant decides to move out, is the tenant responsible to pay the monthly rent until the apartment is leased?
Answer: So long as you attempt to relet the premises, the tenant is still liable for the rent until the lease expires or the apartment is relet, whichever occurs first even if he vacates pursuant to a three-day notice to perform or quit.
2. Question: I have a tenant who decided not to move in after signing a six-month lease and leaving a deposit. Can I hold her to the lease agreement that she signed?
Answer: Once the tenant has signed the lease, he/she is bound by its terms and must pay rent until it expires or the premises are relet, whichever occurs first.
3. Question: If you give residents a sixty-day notice of termination of tenancy and they do not pay their rent for that month, is it okay to give them a three-day notice to pay or quit? The three- day notice does not void the sixty-day notice, does it?
Answer: You can serve them with a three-day notice to pay rent or quit, and if they fail to comply, start the unlawful detainer action. Just make sure you do not ask for rent that goes beyond the sixty-day notice period.
4. Question: I would be interested in knowing what to do when a resident is demanding a repair be made inside of their apartment, but at the same time is demanding that none of the on- site maintenance staff complete the repair. Do we hire an outside vendor or must the resident allow the staff that is available to complete the repair?
Answer: You should find out the reason the resident does not want on-site staff to do the repair. You have the right to choose who should do the repairs for your apartment units.
5. Question: One of my tenant’s sons just turned 18 years old. Should I obtain an application from the son, and add him to the rental agreement?
Answer: You should have everyone 18 years of age or older fill out an application and sign the rental agreement.
6. Question: I had a tenant move out several months ago. I returned $600.00 of his $1000.00 deposit. He disputes all but $50.00 of the deductions and has threatened to sue me. He also has not cashed the refund check. How long does he have to sue me?
Answer: In California, the statute of limitations determines the time that you must bring suit to legally enforce a claim. For written agreements, it is four years from the time of the breach. For oral agreements, the statute of limitations is two years from the time of the breach.
7. Question: I rented to a married couple two years ago and now the wife has moved out and filed for divorce. The husband is still living in the unit. The wife is demanding her portion of the security deposit back since she no longer lives there. What should I do?
Answer: California law does not require that the owner or manager account for the use of the security deposit until the rental unit is vacant and the manager retakes possession. At that time, the manager has 21 days to account for the use of the deposit to any named tenants.
8. Question: I have returned the balance of the security deposit to a former tenant after deducting cleaning charges and insufficient check bank charges. The former tenant claims that I cannot legally deduct the bank charges from the security deposit because that deduction was not specifically stated in the lease. What are my rights?
Answer: California law allows for the use of the security deposit to include other charges than just cleaning, damage and unpaid rent. There is no legal requirement that they must be specified in the rental agreement in order to be enforced by a court.
9. Question: Our tenant gave us a thirty-day written notice to terminate her tenancy. She moved out 10 days after serving the notice and claims she only owes rent up to the day she left. Answer: She is liable up the date the thirty-day notice expires or you relet the premises, whichever occurs first, but only if you first attempt to find a new resident.
10. Question: What constitutes a guest/visitor? I have a resident who left town for 10 days, said his daughter would stop by periodically to water the plants. The next thing I know the daughter's boyfriend is staying in the apartment with periodic visits from the daughter. I called the resident and asked him if he knew someone was staying in his apartment. He stated it was his daughter's boyfriend and he is his guest.
Answer: Unless your lease states how long a guest can stay until they become a resident, you have to rely upon circumstantial evidence, such as receiving mail at the unit, going to and from work on a daily basis, and asking for repairs. If you are month-to-month you can also serve a 30 or 60 day notice without cause unless you are in a just cause rent controlled jurisdiction.
This information is for general information purposes only. Laws may have changed since this was published.