Tracing agent misconceptions
Many agents erroneously believe they cannot give their clients advice on the legal and tax aspects of a transaction, but this is not the case.
Much of the confusion is rooted in the National Association of Realtor® (NAR)’s code of ethics, which suggests that agents avoid sharing their insight about the tax aspects of their clients’ transactions.
Further, the boilerplate statement in the trade union’s listing and purchase agreements incorrectly implies real estate brokers and agents are not qualified to give tax advice to clients in transactions which they are negotiating on behalf of a client.
In law, real estate licensees are not only permitted to share their tax knowledge — hard-earned by education and experience — but may also be required by their agency relationship to do so depending on:
- the scope of the agent’s knowledge;
- the type of property in the transaction; and
- the client’s intended use of the sales proceeds.
When to advise on tax aspects
All DRE licensees acting as an agent owe a general duty to disclose known material facts about a property to all participants in the transaction. Brokers and their agents further owe their clients a specific duty to advise on the consequences of those material facts in the transaction.
Thus, a broker who determines the tax aspects of a sale might affect their client’s decisions in the handling of a transaction has a specific fiduciary agency duty to disclose their knowledge on the tax implications. A prudent listing broker will extend their guidance beyond mere tax information to help their client achieve the tax outcome sought by the client.
For example, tax aspects of a transaction are a material fact to a client in a §1031 transaction. Here, as a matter of basic competency, a broker or agent handling the sale needs to possess an understanding of the fundamental tax concepts affecting the sale — and disclose the extent and nature of their knowledge to their client.
However, on the sale of property that contains one-to-four residential units, the seller’s agent is legislatively relieved of any duty to disclose their knowledge of possible tax consequences of the transaction – even when the agent knows of the tax implications that might affect how the client handles 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 broker or agent who is negotiating the transaction. [CC §2079.16]
On one-to-four units residential transactions, the listing agreement needs to specify the broker and their agents do not undertake the duty to advise on the tax aspects of the transactions. However, on a direct inquiry from their client, the agent is required to respond honestly and to the best of their knowledge. [Carleton v. Tortosa (1993) 14 CA4th 745]
The Agency Law Disclosure addendum attached to listing and purchase agreements further attempts to shift the duty of a broker and their agents to disclose their knowledge about the tax aspects of a sale of property. [See RPI Form 305]
Shifting reliance and avoiding liability
Brokers and agents who give tax advice are best served by contractually involving outside advisors, such as the client’s attorney or accountant. This avoids future claims that the agent’s opinion caused adverse tax consequences for the client — losses that might have been avoided with proper tax advice.
The most practical method for reducing the risk of liability is to insert a further-approval contingency provision in the purchase offer or counteroffer as a contractual reduction of these risks.
The contingency provision places the burden on the client to initiate their own investigation by obtaining a third-party’s further approval of the transaction’s tax consequences from an attorney or accountant before allowing escrow to close.
Under these circumstances, a broker can offer their earnest tax advice and at the same time ensure in writing that their client will ultimately rely on information provided by tax professionals to decide whether or not to close or alter the deal.
Advising clients on the tax implications of a transaction is certainly permitted, and in fact bolsters an agent’s marketability by widening the range of services offered to clients.
Knowledge is power
Knowledge about income tax law in the hands of brokers and agents is a valuable professional tool — especially for clients in income and investment property transactions. Specifically, tax knowledge becomes business goodwill for the brokers and agents involved. In turn, the earning power of goodwill generates further employment by other members of the public, i.e., more and superior listings, repeat clientele and the entrusted handling of larger dollar transactions.
The earlier in the client relationship a broker or agent holds a tax discussion, the more likely the client is to have tax discussions with outside professionals. A client’s early consultation with the relevant professionals allows them to consider — if not embrace — alternatives suggested by their broker or agent, such as a carryback sale for installment tax deferral or the purchase of replacement property in a tax-free §1031 reinvestment plan.
In situations involving other professional advisors, the broker always has a duty of care to present their client with information the broker believes may impact the client. The information may even be reviewed as contrary to erroneous advice given to the client by others, such as the client’s attorney or accountant. [Brown v. Critchfield (1980) 100 CA3d 858]
In contrast, a broker who persuades a client to rely on their advice in lieu of contrary advice from other professionals will be liable for any losses suffered by the client due to the broker’s unsound advice. Agents need to let the client make their own decision regarding whose advice to follow — while requiring a further-approval contingency provision in order to shift reliance from the agent to a third party. [In Jogert, Inc. (1991) 950 F2d 1498]
Disclosures benefit the broker
The sale of every parcel of real estate, except dealer property, produces income taxed as profit — known as gain —when the price exceeds the seller’s cost basis in the property. This profit formula, coupled with an understanding that taking a profit on the sale usually produces a tax liability, is knowledge common to all brokers and sales agents who represent sellers or have owned property. Most sellers also know this, except those whose real estate transactions are limited to the sale of their principal residence.
A broker and their agents handling a one-to-four unit residential property are not legally obligated to mention tax consequences or disclose any aspect of their tax knowledge to their buyers or sellers. The disclaimer provisions in the mandated agency disclosure law advising buyers to obtain competent tax advice do not shift the duty to disclose tax aspects known to the broker or agent involved. [See RPI Form 305]
However, a broker with knowledge of the tax aspects of real estate transactions needs to consider assisting their client by:
- giving tax advice on the transaction to the best of their knowledge;
- disclosing the source of the information on which they formed an opinion for the advice given; and
- conditioning the transaction on the client’s right to cancel the purchase agreement by including a further-approval contingency provision regarding clearance of the transaction’s tax consequences with a third party before closing.