Our proposal: Mandate real estate agents and brokers disclose to their client known tax consequences of a transaction that may affect their client’s decision.
Why: Every property transaction involves tax consequences for the client. Some tax aspects may even rise to the level of material facts when they affect how the client will handle the transaction — for example, in a §1031 transaction. Accordingly, an agent has a fiduciary duty to their client to disclose the extent of their knowledge of the transaction’s tax aspects.
A knowledgeable agent is further able to go beyond disclosure of tax information by assisting their client in structuring the sales arrangement to achieve the best tax outcome available.
However, a statutory exception to the tax disclosure duties currently exists on one-to-four unit residential dwellings and commercial properties. A seller’s agent has no duty to disclose their knowledge of possible tax consequences, even when they are known by the agent to affect the client’s decision on how to handle the sale of the property. [Calif. Civil Code §2079.16]
In this case, clients are expected to obtain tax advice from competent professionals other than the real estate brokerage office handling their transaction. [CC §2079.16]
Our proposed legislation would ensure transparency between the agent and client in an effort to combat the wide-spread phenomenon of the “dumb agent” — the agent who, despite their knowledge, is legally allowed to remain silent about consequences known to them in a property sales transaction.
The preprinted, boilerplate advisory to see another professional about the tax aspects of a transaction does not disclose the agent’s knowledge that might affect the client’s decisions. Thus, it is a material fact deceitfully omitted by the agent which disadvantages their client.
Yet, tax aspects are basic to the sale or ownership of any real estate commonly listed and sold by agents. When applicable, they have significant financial impact on sellers and buyers of real estate. Brokers and agents handling the sale of real estate used in the client’s business or held for investment, in particular, will possess an understanding of several fundamental tax concepts affecting the sale, such as:
- the principal residence owner-occupant’s individual $250,000 profit exclusion on a sale;
- the separate income and profit categories for different types of real estate;
- the §1031 profit reporting exemption;
- interest deductions on mortgages;
- depreciation schedules and cost recovery deductions;
- the $25,000 deduction and real-estate-related business adjustments for rental property losses;
- the tracking of rental income/losses separately for each property;
- profit and loss spillover on the sale of a rental property;
- standard and alternative reporting and their tax bracket rates; and
- installment sales with deferred profit reporting.
Thus, as a matter of practice, most real estate licensees have a working knowledge of the tax aspects of a sale. Agents are fully capable of delivering known tax information to clients, even if they do not possess the expertise to provide more comprehensive tax advice.
What you can do: As a professional tool in the hands of brokers and agents, knowledge about income tax law is a valuable asset for assisting clients. Tax knowledge becomes business goodwill, which generates further employment through more and superior listings, repeat clientele and the entrusted handling of large dollar transactions.
To capitalize on the tax knowledge you have spent time acquiring, disclose to clients the extent of your knowledge on the tax results of their transaction, regardless of the type of property involved. Counseling a client on the tax aspects of a sale, purchase or reinvestment early on in an agency relationship typically induces an ongoing tax discussion. It is a material concern to all parties in any real estate transaction.
At the time you take a listing and before entering into a discussion about the tax aspects of a sale, prepare an Individual Tax Analysis (INTAX) form. On it, you may break down the profit taken on a sale into the different types of gains, called batching, to estimate the seller’s tax liability on closing. [RPI Form 351]
During a review of the INTAX form, you will need to discuss methods available to the seller to exclude, exempt or defer profit or taxes on the transaction under consideration.
This evaluation will help the seller consider a §1031 reinvestment plan to acquire a replacement property, or structure the sale as an installment sale. The INTAX form will likely need to be reviewed again when a purchase agreement offer or counteroffer is reviewed for acceptance. The discussion with the seller on each occasion should be limited to the amount of profit on the sale, the batching of different gains and the tax liability due on those gains.
However, beware that a broker or agent who provides tax advice has a duty to not mislead the client by intentional or negligent misapplication of tax rules. [Ziswasser v. Cole & Cowan, Inc. (1985) 164 CA3d 417]
To avoid this dilemma, be sure to disclose to your client:
- the full extent of your tax knowledge regarding the transaction;
- how you acquired this tax knowledge; and
- whether you intend to further investigate the matter or whether the client should seek further advice from other professionals.
You are strongly advised to involve the client’s other advisors, such as their attorney or tax accountant. While you need to maintain your influence over your client’s decisions — your opinions are relevant and important, after all — your input is not necessarily conclusive.
Encouraging a client to discuss the transaction with other advisors available to them results in their greater cooperation with you as their agent or broker. More importantly, it helps eliminate future claims arising from adverse tax consequences said to be due to your client’s reliance on your opinion.
Failure to recognize and coordinate transaction activity with other advisors can produce deleterious results for you. Persuading a client to rely on your advice to the exclusion of contrary (and potentially correct) advice of other professionals will cause you to be liable for any losses suffered by the client due to your unsound advice. It is best to give advice and let your client sort out all the advice they receive and, importantly, make their own decision regarding whose advice to follow. [In re Jogert, Inc. (1991) 950 F2d 1498]
The most effective method for shifting reliance to other qualified professionals or to the client is to insert a further-approval contingency provision in the purchase offer or counteroffer. The provision requires the client to initiate the investigation by obtaining additional tax advice and further approval of the transaction’s tax consequences from an attorney or accountant before allowing escrow to close.
An oral or written warning, or general advice to further investigate — such as the disclaimer statement in the Agency Law Disclosure — is insufficient due to the ill-defined term “legal advice.” Advisory statements do not require the client to act, nor do they explain why their broker or agent believes the client needs to act to protect themselves. A further-approval contingency provision makes the advice an opinion, to be confirmed by the client before closing. [Field v. Century 21 Klowden-Forness Realty (1998) 63 CA4th 18]
Inclusion of the provision mitigates any risks, allowing you to confidently offer your clients the benefit of the full breadth of your acquired tax knowledge and experience.