by Ellen Romano with Robert Griswold, CRE, CPM, ARM
Deposits? || Opening
What you don't know can hurt you. Especially when it comes to property management trust accounts. In California, the most common violation of broker licensing laws occurs in the administration and handling of trust funds, according to Robert Griswold, CPMŪ, head of Griswold Real Estate Management in San Diego.
Handling property management trust accounts correctly is complicated by the fact that these fiduciary accounts are regulated by state law, thus the rules governing them vary widely from state to state.
Some trust account regulations were created to govern escrow accounts used in buy-sell transactions rather than property management activities such as rent collection and security deposits. As a result, they may contain provisions - such as requiring that all deposits be made within 24 hours - that are difficult for property managers to comply with. The National Association of REALTORSŪ, the Institute of Real Estate Management (IREM), and other property management organizations have lobbied successfully in several states to ease these requirements and to have property management trust accounts regulated separately from escrow accounts for property sales.
Some states are moving away from prescriptive regulation of these accounts. Under Wisconsin's revised law, which became effective in October 1994, many of the details of how the trust accounts. Under Wisconsin's revised law, which became effective in October 1994, many of the details of how trust accounts will be handled must be negotiated between the owner and property manager and specified in the management contract. Even if there are specific laws in your state, including a description of how trust accounts should be handled in the management agreement is sound business practice.
A trust account is a fiduciary account established to hold funds that belong to another party. The California Department of Real Estate defines trust funds as "money or other things of value that are received by a broker or salesperson on behalf of a principal or any other person, and which are held for the benefit of others in the performance of any acts for which a real estate license is required." The laws governing trust funds usually apply to all licensed real estate professionals and are administered by the state licensing agency.
In most states, all funds belonging to building owners and security deposits received from tenants must be placed in a trust account. "Generally any funds that a broker collects that have to do with a property should be put into the trust account," says Chris Ratliff, auditing supervisor for Arizona's Department of Real Estate. "If a complex has pop machine and a laundry room, then those funds should also be deposited in the trust account and accounted for as if they are owner funds."
Some states allow for owners' accounts, into which owners' funds are deposited, and which are not considered to be trust accounts. Recent changes in Wisconsin's statute clarified that owners' operating accounts were not trust accounts. Says Fred Prassas, CPMŪ, Property Management Concepts, Ltd., La Crosse, Wis., "Before we made these changes, the regulatory authorities could have chosen to call any owner's operating account trust funds and made them subject to all of the regulations that were in effect."
Generally funds such as real estate commissions, management fees, and deposits from broker-owned real estate should not be deposited into owner trust accounts and should never be commingled with owners' trust funds.
Most states consider tenants' security deposits to be the property of the tenant and require that they be kept in a trust account, (In a number of states, such as Michigan and New York, security deposits are regulated under landlord-tenant laws rather than by the department of real estate.)
Some states allow the property manager to keep security deposits in the same account as owners' funds; others, such as New York, require that they be kept separate.
Whether the property manager is permitted to use security deposit funds while they are on deposit is also regulated. For example, in Michigan, once security deposits are placed in a regulated financial institution, the landlord can use those funds as long as he or she deposits with the secretary of state a cash bond to secure the entire deposit.
Under Wisconsin regulations, security deposits must be kept in a trust account only if they are held by the broker in a brokerage account. If the owner holds the security deposits in the owner's account, it is not a trust situation. "In our company," says Prassas, "for the smaller properties, the owner's accounts are run out of a trust account and the security deposits are kept segregated in that trust account. In the case of the larger properties, the security deposits are kept in the owner's operating account, over which we have signature power, but which were defined not to be trust funds.
Trust funds generally must be kept in a federally insured back or savings and loan association located within the state.
The account must be identifies as a trust account with the broker as trustee. "These funds are considered to client funds," says Roland Runion, chief auditor of the Washington Department of Licensing. "They are not funds of the brokerage, and therefore are not attachable in bankruptcies and lawsuits as an asset of the firm."
Some states require that any signer on a trust account be a licensed real estate broker. Others permit an unlicensed employee of the broker to be a signer. In Arizona, for example, the signer on a trust account may be either a licensee or an unlicensed natural person (as opposed to a corporation), and that natural person must either be an officer of the company or in its direct employ or supervision.
In some instances, an unlicensed signer must be bonded. California requires that an unlicensed employee who is an unlicensed employee who is a signatory on a trust account be covered by a fidelity bond that is at least equal to the amount of funds to which the employee has access at any time.
Most states do not care if a property manager sets up one or multiple trust accounts for different owners. Ratliff says, "We find that generally property management firms that manage multiple complexes for different owners will set up an individual trust account or multiple trust accounts for each complex. They do that solely so that the accounting is separate and it's all right there for the owner to see."
Ratliff says many firms also set up two trust accounts - an operating trust account and a tenant security deposit trust account - just to keep them separate. "They don't want to make a mistake and overdraw the owner's fund and expend the security deposit for repairs on the property." In such cases, he says the security deposits typically are placed in a savings account, while the bills and the owner's distributions are paid out of the operating account. Security deposit refunds are taken from the owner's account, then that amount is transferred from the savings account into the operating account to replace those funds.
Some states permit trust funds to be placed in an interest-bearing account as long as the management states this and specifies who receives the interest. In other states, funds must be places in a non-interest-bearing account.
"Interest on security deposits is a very touchy thing, "says Griswold. In California, normally they are not placed in an interest-bearing account unless the client requests it in writing. Says Griswold, "The funds must be placed in a totally separate account. You must keep your client constantly informed on the terms of the deposit - the interest rate, maturity, the actual APR, things like that." The broker may not collect any earned interest on funds, even with the authorization of the owner.
In New York, which has few regulations specifically covering trust account operations, general obligation law permits all rent security deposits to be placed in interest bearing accounts, but requires it for properties of six or more units, says Ralph Fallarino, assistant counsel of New York State's Banking Department. If the funds are placed in an interest-bearing account , the landlord is entitled to receive 1 percent of the interest as the administrative expense and the tenant receives the balance.
In Arizona, the interest is a matter for discussion between the manager and the owner, says Ratliff, and must be specified in the management agreement. When the funds are in an interest-bearing account, he says, there is usually a disclosure in the lease that the security deposit will be held in the broker's interest-bearing account and the interest will be used by the broker too offset banking and accounting costs.
Until recently, Michigan law prohibited collecting intersection trust accounts. One real estate manager tells of a property manager who got written up from keeping owner's funds in an interest-bearing account for the benefit of the owner. "We told [the legislature] we work for large insurance and pension funds, and if we told them we couldn't put [their money] in an interest-bearing account, they wouldn't hire us," says Robert Bessert, CPMŪ, Piper Realty Company, Flint, Mich.
In Wisconsin, Prassas says, changes in the law would have required banks to pay interest on broker's trust accounts and remit interest to the state to fund programs for the homeless. "We were able to keep property management trust accounts out of that particular legislation," says Prassas, by creating two different types of trust accounts.
One of the most problematic requirements of trust accounts concerns how quickly funds must be deposited. In California, all funds received in connection with purchase or lease of real property must be deposited in the trust account no later that the next business day. "Where the problem usually occurs, " says Griswold, "is when you get somebody who paid the rent late, they're fined a late charge of $10 or $25, and they come in on the 20th of the month with the late fee. The law says even if it's only $20 or $10 you must deposit it by the close of the next business day."
Arizona also has a 24-hour requirement, but it now applies only to sales escrow accounts. The state has revised its law to give property management firms up to three days to deposit funds. The reason for the change, says Ratliff, is that it was difficult for large property management firms, who generally collect most of their rent between the first and the fifth of the month, to collect all rents, make out the deposit slips, and get funds in the bank in one day.
Wisconsin has loosened its requirements of timely deposits from 24 to 48 hours, while Michigan now has no specific requirements for when funds must be deposited. "Instead, the property manager's employment contract dictates all of that," says Michigan's Chief Auditor, Connie, McKenzie. "We've moved from statutory requirements to letting the contract govern.
The most serious accounting violation in a trust account is the commingling of owner and broker/manager funds. Depending on state law, commingling may be considered to occur when:
Griswold gives an example of commingling client's funds: "You have clients A, B, C, and D, and client C's mortgage is due. The tenants are slow paying their rent this month, but you write the check anyway. While it clears the bank, technically it's overdrafted the amount of funds client C has in the account. In effect, you've used client D's funds to pay this other client's bill. That is obviously would be a serious violation."
In California, client trust funds are considered to be commingled with broker funds if the management fee is not withdrawn on time. For example, says Griswold, assume that by contract your management fee for the month of February is to be paid as of March 1. If you do not remove those funds within 25 days of when they are earned, you would be in violation of commingling funds.
Ratliff says some computer programs automatically transfer the management fee internally from the owner's column to the broker's column when the rent is paid. If the firm is on an "as earned" accounting system, the broker may draw half the money out on the 15th of the month and the balance at the end of the month. If there is a shortage in the owner's account, the property manager can temporarily transfer some of the broker's fee back to the owner's side of the ledger to cover it. "That would not be looked on as commingling brokerage funds with owner funds. That's the established accounting system, and they do the same thing every single month, month after month."
Sometimes the statue permits the broker to keep a certain amount of his or her money in the trust account to offset service fees and other bank charges. In California, the broker may keep up to $100 of personal funds in the account to cover bank expenses, but the preferred practice is to have the bank debit the broker's personal account for these charges.
Washington's regulations in this area are more stringent. "No broker funds of any nature may be mixed with client funds," says Runion. "If an owner wants to set up and maintain reserve, that would be stated in the management agreement. Brokers may not even put $1 of their money in to open a trust account. They have to make arrangements with the bank to make sure the trust account will open and stay open even if it hits zero balance."
Trust account regulations often specify how long records of trust account transactions must be kept. A common requirement is that they be held for at least three years after the close of the transaction.
Ratliff says may of the large firms retain their trust account records longer, particularly if they continue to manage the property. "In this day and age," he says, "I tell brokers constantly, 'Keep any paperwork you think you may need to defend yourself at a later date.' It's not necessarily to defend themselves from the Real Estate Department, it's to defend themselves from an owner."
Some states regularly audit trust accounts. Washington has a proactive compliance auditing program in which every firm is audited at least once every two years. "If their records are in marginal condition," says Runion, "but there's nothing serious enough to take an administrative action against their license, they go on what we call a priority audit. Those are every year until they come out with a cleaner audit. Then they'll go back on the regular schedule.'
Other states conduct audits only when they receive a complaint. "In the past, we audited when there were complaints, and we also did routine audits," says Wisconsin's McKenzie. "With the change in the law, our emphasis will probably be more on complaint audits because there's going to have to be a property management contract for us to look at and determine what the requirements are".
"Arizona's audits are not only investigational, we also do educational audits," says Ratliff. "If the broker has a question or doubt, if he is not sure the system is doing what they want it to do, they will request a broker audit. Washington's Real Estate Department offers "new firm visits" in which a senior auditor will go over all the procedures with brokers "to make sure they are getting off on the right foot," says Runion. "This has been very well received."
It is critical for property managers to be aware of trust accounts and to do their own internal audits, says Griswold. "It's very easy for a management company to get caught up in the day-to-day management activities and forget about the back room stuff that is so critical. Yet improper accounting is a sure thing that's going to lead to loss of an account plus potentially the loss of your license."
From the Journal of Property
Robert Griswold and the Real Estate Today! radio show strongly support the intent and the letter of all federal and state fair housing laws. As a reminder to all owners and managers of real estate, note that all real estate advertised is subject to the Federal Fair Housing Act, which makes it illegal to advertise "any preference, limitation, discrimination because of race, color, national origin or ancestry, religion, sex, physical disability, or familial status, or intention to make any such preference, limitation or discrimination." Additional state and/or local fair housing laws may also apply. Be sure to inform all persons that all dwellings offered or advertised are on an equal opportunity basis.
Revised and Updated - Wednesday, April 26, 2006
Robert S. Griswold, CRE, CPM, CCIM,
PCAM, GRI, ARM
Đ2006, 2005, 2004, 2003, 2002, 2001, 2000, 1999, 1998, 1997, 1996 Robert S. Griswold.
All Rights Reserved.