COMMERCIAL ESCROW SETTLEMENT
A commercial escrow is one that involves the transfer or encumbrance of
property other than residential, such as office, research, retail and
industrial properties.
Alamo Title® recognizes that there is no such thing as an easy
commercial transaction. Each transaction is unique and the main role
of the settlement agent becomes that of a coordinator and problem
solver. Often a transaction will become so complex that the settlement
agent is the only person who has a grasp of the entire transaction and
all closing requirements. Handling commercial escrows requires unique
skills on the part of the settlement agent.
For more specific information regarding commercial real estate
transactions and the processes and procedures required to successfully
close, select from the Commercial Closing Topics index provided.
Commercial Closing Topics
Opening the Escrow Transaction
An escrow transaction is commonly opened by the real estate agents or
attorneys involved in the transaction. The specific transaction
information required to open the order may be communicated to the
escrow settlement officer by telephone, facsimile, by email or
in person. The following minimum information is required at the time
of opening:
- Sale Price/Loan Amount
- Property Address(es) and/or Legal Description
- Assessor’s Parcel Number(s) (if available)
- Policy Liability Amounts (if available)
- Owners/Borrowers
- Buyers
- Contact Information for Professionals (such as listing/selling agent, attorneys and lenders)
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Fee Quotes
Escrow closing fees are provided by quote based on the closing location
and the complexity of the transaction. To obtain a closing fee quote,
use the Find an Office option located on this page to find an escrow
closing office near you.
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Deposit Funds
Commercial escrow deposits are typically large sums of money held for
long periods of time. Frequently multiple deposits are required through
the course of the transaction as contract contingencies are fulfilled.
At the time of contract negotiations, the principals to the transaction
will typically decide which party will be entitled to any interest
earned on those deposits at the successful close or cancellation of
the transaction.
The party entitled to the earned interest will have to complete an
authorization provided by the escrow settlement officer, as well as
a Form W-9 providing the taxpayer identification number for the
earning party. These two documents are required by the escrow
settlement agent and the bank that will be required to hold the
deposit in trust on behalf of the escrow settlement agent and the
principals.
The bank will report the interest earned to the Internal Revenue
Service based on the taxpayer identification number provided.
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In General
The escrow settlement agent will work closely with the principals
and their representatives to ensure title issues are resolved, that
authoritative documents are requested from the principals, future
deposits and release of funds occur within the agreed upon time
constraints.
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Coordinating Title Issues
Escrow settlement agent will make requests for inspections, survey
requirements, owner’s affidavit, leases (recorded and unrecorded) prior
to closing the transaction.
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Information Gathering
During the contingency period, the settlement agent will work to gather
the information and documents necessary to prepare the closing statement
and closing documents. The list of documents and information required
by the settlement agent may be revised throughout the course of the
transaction as documents and information are received, the terms of
the purchase agreement change, or if the parties request any additional
services or products.
The initial list of documents and information needed by the settlement
agent are as follows:
- Organizational Documents for the Entities
- Copies of Leases
- Rent Roll with security deposits
- A list of service contracts or other items to be prorated at closing
- A list of personal property to be included in the Bill of Sale
- At least two (2) copies of the survey
- Original documents as attached as exhibits to the contract for execution at closing
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Organization Documents and Verifying Authority
When the seller or buyer is not a natural born person, the settlement
agent and title insurer must verify that the entity was properly formed
and that the person(s) signing the documents are duly authorized and
have the power to sell and/or loan money, or to buy and/or borrower
money. If the closing documents are not signed by a duly authorized
representative of the corporation, trust, company, partnership, etc.,
the transaction may be voidable.
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Demand/Lien Information
The settlement agent will obtain information from the Seller for all
existing liens which will have to be satisfied or removed at closing.
This includes information on trust deeds or mortgages to be paid off,
and also includes tax liens, judgments, and defects in title or
unrecorded leases. If a Seller is deceased, probate documents will be
required. A Seller in bankruptcy will need a court order.
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Prorations
There may be many items to prorate in a real estate transaction. As in
any other transaction, how an item is prorated will depend upon whether
or not it is paid in arrears or in advance.
Items to prorate at closing include:
- Real estate taxes
- Personal property taxes
- Special assessments
- Rents
- Property owner’s assessments
- Common area maintenance fees
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Rents, Tenant Deposits and Estoppels
The Rent Roll is a list of tenants and units, rents due and delinquent,
and tenant deposits. It is customarily obtained by the settlement agent
from the seller or property manager. Rent may also include other items
such as rental tax, liability insurance, common area maintenance, taxes,
etc.
There are two distinct methods to prorate rents at closing:
1. Rents actually collected
2. All rents, as if collected
The purchase agreement should state the manner in which rents are to
be prorated. If not, the settlement agent must ask the question of
both sides of the transaction.
Tenant deposits are not prorated, however, the entire amount of the
deposits are transferred from seller to buyer at closing in one of
two ways:
1. charge (debit) the seller and credit the buyer (usual practice); or
2. charge the seller and issue a check to the buyer (by special request)
Tenant deposits may include such items as security or damage deposits and last
month’s rent, which are usually itemized on the rent roll.
A Tenant Estoppel is a document signed by the tenant confirming the
terms of the lease. By the nature of an “estoppel”, the tenant would
be estopped (prevented) from asserting any other rights in the future
other than those stated in the lease.
Tenant Estoppels are typically a contractual issue between buyer
and seller. It is the responsibility of the seller to provide a form
of Estoppel that is acceptable to the buyer, to obtain the tenants’
signature and to deliver the estoppels to the buyer.
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Tax Deferred Exchange
Section 1031 of the Internal Revenue code of 1986 (as amended), offers
real estate investors an opportunity to build wealth and save taxes. In
a tax deferred exchange, the investor (Exchanger) can dispose of
investment property and defer the capital gains tax by leveraging all
their equity into replacement property. Two requirements must be met to
defer the capital gain:
1. The Exchanger must acquire “like-kind property”
2. The Exchanger cannot take “constructive receipt of funds” (receive proceeds)
Here is what happens in such an exchange:
- The Exchanger must enter into an exchange transaction prior to closing on the relinquished property.
- The Exchanger enters into an Exchange Agreement with a Qualified Intermediary (Exchange Accommodator)
- The Intermediary acquires the relinquished property from the exchanger and transfers it to the buyer by a direct deed from the Exchanger
- The proceeds from the relinquished property are assigned to and held by the Intermediary in a separate, secure account.
- The Intermediary acquires the replacement property from the seller and transfers it to the Exchanger by a direct deed from the seller.
- The exchange funds are used by the Intermediary to purchase replacement property for the Exchanger.
There are strict time limits in which a tax deferred exchange must be
completed with absolutely no extensions:
- The Exchanger has 45 days from the date the relinquished property closes to identify potential replacement properties in writing to the Intermediary. Once the 45 days has expired, the Exchanger may not change the property identification list and must close on one or more of the identified properties.
- The purchase of the replacement property must be completed within 180 days from the date of closing on the relinquished property.
Although property is deeded directly between seller and buyer, the
Intermediary should be shown on the closing statement and should sign
the closing statement on behalf of the Exchanger. The Exchanger approves
the closing statement and typically signs all other closing documents.
An Exchanger may also enter into a “Reverse Exchange”, in which the
replacement property is purchased prior to closing on the relinquished
property.
A tax deferred exchange is also subject to 1099-S reporting and
FIRPTA regulations and withholding.
There are many things an investor must consider when thinking about
entering into a tax deferred exchange. Interested parties should
contact a tax advisor or an attorney who specializes in tax matters,
and to speak directly to a qualified exchange accommodator.
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1099-S Reporting
The Internal Revenue Code requires that all proceeds from the sale or
exchange of a real estate transaction be reported to the IRS. All real
estate transfers are subject to 1099-S reporting, including commercial
properties, regardless of whether or not there is any consideration
paid for the property.
All transferors (sellers) are subject to 1099-S reporting, including
individuals, estates/trusts, partnerships, sole proprietorships,
limited liability companies. Even foreign sellers are subject to
1099-S reporting, regardless of whether or not FIRPTA taxes are withhold
and paid. Corporations are not subject to 1099-S reporting.
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FIRPTA – Foreign Investment in Real Property Tax Act
Section 1445 of the Internal Revenue Code requires that the
transferee (buyer) must deduct and withhold a tax equal to 10%
(or other amount) of the total amount realized (total sale price
or consideration on the disposition of a U.S. real property interest
by a foreign person (transferor/seller). Taxes and forms must be
submitted to the IRS within 20 days of the transfer.
All real estate transactions/transfers, including exchanges, are subject
to FIRPTA regulations; however, many commercial contracts contain
provisions for the seller’s cooperation with FIRPTA compliance at
closing.
There are ten (10) different FIRPTA exemptions, including the Non-Foreign
Certification (refer to IRS publication 515). The foreign transferor
must prove to the buyer and to the settlement agent that an allowed
exemption applies to the transaction.
Because the buyer is held responsible by the IRS, the buyer should be
kept in the loop regarding any matters pertaining to FIRPTA and foreign
sellers. Many state’s (California and Hawaii) have their own FIRPTA
regulations that are enacted if one or more of the properties are
located within that state.
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Property and Casualty Insurance Requirements
Insurance coverage is required to be evidenced at closing, if there
is a new lender involved in the transaction. Sometimes the lender's
attorney will deal directly with the insurance company. The
settlement agent will require contact information for the buyer’s
insurance agent prior to closing.
Depending on the type of property, and the Buyer, the method of
paying insurance premiums can vary. A large client may have master
policies and no premiums will be paid in escrow. A buyer may set up
an installment and only a portion of the premium will be paid through
escrow.
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Proformas
A lender or attorney may request a “proforma”. What they are asking
for is a sample policy and samples of the endorsements they require at
closing. The title examiner will prepare the “proforma” for delivery
to the parties to the transaction.
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Endorsements
An “endorsement” is a rider issued to a policy of title insurance that
insures over a particular matter or provides additional coverage to the
insured. Endorsements may be customized to meet the particular needs
or concerns of the proposed insured or the nature of the property to
be insured, and may be applicable to either the owner’s or the lender’s
policy, or both.
Whenever a title company is asked to endorse around or insure over a
specific matter, there may be certain conditions that must be met
depending upon the subject matter of the endorsement, before the
endorsement can be issued. All endorsements are subject to approval
by the title underwriter.
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Re-Insurance
The title insurer will insure up to the total sale price or loan
amount, and then employs another title insurance company to insure
them. The premium paid to the re-insurance title company is deducted
from the title fees; it is not an additional charge to the parties.
Re-insurance is handled by the Title Department when requested by the
proposed insured or is required based upon self-imposed or statutory
title insurance limits.
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Co-Insurance
The proposed insured may only allow the title insurance company to
insure up to a certain amount (i.e. not the total sale price or loan
amount). The insuring company must employ another title insurance
company to insure the remainder of the sale price or loan amount.
When there is co-insurance, the customer is charged based upon each
company’s filed rates for the portion of the total liability covered
by that company. The co-insurance company may be chosen by the
customer.
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UCC Search
A Uniform Commercial Code (UCC) search is conducted through the
Secretary of State for any Financing Statements that may have been
filed to perfect a lien on personal property in accordance with the
Uniform Commercial Code. The search is conducted on name(s) of the
Debtor(s) as well as the location of the property. This search is
not a part of the preliminary report or commitment provided by the
title insurer, but an outside provider company that specializes in
such reports. There is an additional cost for the UCC Search,
which cannot be determined until after the search is completed and
provided to the settlement agent.
A UCC Search through the Office of the Secretary of State is not
conducted unless required under the terms of the purchase agreement
or requested by one of the parties. The names to be searched must
be provided to the settlement agent if any name other than the seller
or buyer as it appears on the purchase agreement or preliminary
report/title commitment are to be included in the search. The
settlement agent needs to be provided the names to be searched in
writing by the requesting party. The cost of the final report must
be paid for by either buyer or seller. If the report is produced
early in the transaction processing period, it may need to be updated
prior to closing, resulting in additional charges.
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UCC Filings
Many lenders will require a UCC-1 Financing Statement to utilize
personal property as additional security for their loan. A UCC-1
Financing Statement may be recorded in the County in which the real
property is located. The UCC-1 is typically recorded concurrently
with and after the deed of trust or mortgage instrument or as instructed
by the lender.
A UCC-1 Financing Statement should be filed with the Secretary of State
in the jurisdiction of the location of the debtor. Enforcement of a
debt secured with a UCC Financing Statement comes under the Uniform
Commercial Code. It is actually the state filing that perfects the
lien. In the case of an individual, it should be filed in the state
in which they reside. In the case of a legal entity, it should be
filed in the state in which the entity was organized. For example,
if the debtor has its primary residence in Arizona, the UCC-1 would
be filed with the Arizona Secretary of State. If the Debtor is a
California Limited Liability Company, the UCC-1 would be filed with
the California Secretary of State.
The Secured Party and the Debtor should determine the location of
recording and or filing of the UCC statement. The completed UCC-1
Financing Statement is normally provided by the lender.
UCC-1 Financing Statements do not have to be signed by either the
Debtor or Secured Party; however, they must be authorized. This
means that the parties must instruct the settlement agent, in writing,
to record the UCC with County Recorder and/or to file it with the
Secretary of State, naming the county recorder and the state
jurisdiction.
Although the UCC-1 Financing Statement does not require signatures,
any attachment such as the legal description or special terms and
conditions may require the signature of the Debtor.
A UCC-1 Financing Statement expires after five (5) years, unless a
continuation is recorded and/or filed. It is the sole responsibility
of the Secured Party to determine if a continuation is necessary and
to record and/or file any continuation statement.
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