Real Estate 2023

Last Updated May 04, 2023


Law and Practice


Rosen Karol Salis, PLLC has been providing legal services in the franchise and real estate fields since 2005. The firm has represented franchisors, franchisees and real estate entrepreneurs in all business and legal areas, worldwide. Senior partner, Richard L. Rosen, has over 40 years of experience as a franchise lawyer, business attorney and real estate developer. Richard and the firm have won dozens of franchise awards and authored many articles. The firm authored the “Defending Franchisor Claims” chapter in Representing Franchisees, a handbook (to be published) by the American Bar Association’s Forum on Franchising.

Real property law in the United States is primarily derived from the common law of the states and has been modified over time by statute. However, certain aspects of real property law are governed by federal law. For example, discrimination in real estate transactions on account of race, colour religion, sex or national origin is prohibited by the Federal Fair Housing Act. Environmental issues affecting real property are typically governed by federal law.

The United States real estate market is being affected by various macroeconomic factors.

  • High inflation: Inflation remains at historical highs not seen since the 1980s. Inflation affects the ability of individuals and families to buy or rent. The increased cost of labour and materials also affects the costs of owning and operating commercial real estate. Further, these factors also affect the ability of commercial tenants to operate profitably and pay the rents that landlords require. The combination of these factors has had a negative impact generally on the commercial real estate market.
  • Increasing interest rates: The target federal funds rate has increased from historical lows to the current rate of 4.75–5% (many residential borrowers will see interest rates of 7% or more), which affects housing affordability from the buyer side. From the seller’s side, there is a greater incentive to hold onto a home with a historical low interest rate mortgage rather than either upgrading or moving to a new home.
  • Geopolitical issues: The ongoing war in Ukraine, sanctions and rising tensions between the USA and China will continue to drive up energy prices and ensure that supply chain issues persist.
  • Low residential inventory: The residential real estate inventory in many prime US markets remains low (resulting in higher costs) because of the lower rates of homebuilding. This is affected by further high demand persisting from the effects of the coronavirus pandemic.
  • Low vacancies in multi-unit (rental) properties: Many large US cities have low vacancy rates in residential rental units, meaning that there is competition between potential renters resulting in continued upward momentum in pricing (although some smaller market cities have shown a cooling in prices as the rate at which new residents are moving from large to smaller markets has slowed with the push against remote work by many employers).
  • Office space: It is not clear whether commercial office tenancies will ever return to pre-pandemic occupancy levels. That uncertainty, in and of itself, has resulted in negative psychology in the commercial rental market.
  • Retail space: The demand for commercial retail space depends on the location. While the allure of in person shopping has survived e-commerce, retail outlets in city centres have suffered from the slow return of workers to the retail marketplace.
  • “End” of the COVID-19 pandemic: The Biden administration has announced that the national emergency and public health emergency declaration regarding the coronavirus pandemic will formally end on 11 May 2023. However, the recovery of commercial real estate (particularly in the retail sphere) remains slow.

Blockchain offers a variety of possibilities for the real estate industry, including the development of various blockchain-based applications that will help buyers and renters connect with sellers and landlords, respectively, in a transparent manner. Blockchain transactions also provide protection against fraud, being conducted on an “immutable register” which is un-tamperable. The use of self-executing “smart contracts” also provides an alternative to transactions which can potentially remove the use of intermediaries and constant “back and forth” between the parties which prolongs transactions. When third parties are removed from transactions, there is a reduction in transactional costs which benefits one or both of the parties.

For example, a typical residential real estate transaction in New York state involves the parties’ attorneys, the bank attorney, real estate brokers, a title agent and typically, a mortgage broker or bank representative, the roles of which may be automated in the future.

The Inflation Reduction Act of 2022 (IRA) is currently being implemented by the Internal Revenue Service. The IRA provides various incentives and tax credits to businesses and organisations to reduce the costs of renewable energy. The following are components of the IRA that should affect the real estate industry, directly or indirectly:

  • The Energy Efficient Commercial Buildings Tax Deduction provides a tax deduction for the real estate industry encompassing the transition to energy-reducing technologies; the amount of this tax deduction, adjusted annually for inflation, is estimated to be USD0.30–1.80 per square foot, depending upon the technology that has been implemented.
  • The Renewable Energy Productive Tax Credit provides a corporate tax credit available to commercial and industrial sectors that implement various renewable energy technologies including geothermal electric, solar and wind; unused credits may be carried forward for up to 20 years (and one year back).
  • The US Department of Energy’s Loan Guarantee Program provides funding to various sectors, including the real estate industry, that implement the energy technologies described above.

Property rights may be acquired in the form of a fee simple ownership interest, a leasehold ownership interest, an occupancy interest under a licence agreement, or as a non-possessory interest. Fee simple ownership is an equity interest that generally gives the property owner full ownership rights to the land and any improvements constructed thereon. Such rights include, but are not limited to, the ability to sell, lease, devise, or mortgage the property. A leasehold interest is created by an agreement between a landlord and tenant that provides the tenant or lessee with the exclusive right to possess the property over the lease term. Many jurisdictions have enacted specific tenant protections regarding evictions and the withholding of security deposits, to name a few. The holder of an occupancy interest, or licence, is permitted to use another’s property for a specific purpose. Unlike a lease, a licence cannot be transferred, and the property owner can revoke it at any time. An easement conveys a non-possessory interest in land whereby the property owner grants another the right to use and access their property for a specific purpose. An easement differs from a licence, which cannot be transferred, in that it “runs with the land” and can be transferred. For example, utility companies typically hold easements that permit them to locate, access and utilise utility poles on another’s land.   

States have enacted real property laws that set forth the requirements necessary to transfer title to real property. Typically, a transfer of ownership is completed upon the delivery by the seller and acceptance of the deed by the buyer. While there is no requirement to record a deed to real property, it is imperative to do so to preserve one’s property rights, as in many jurisdictions, a conveyance that is not recorded is deemed to be void against a subsequent bona fide purchaser for value. Local jurisdictions establish the requirements and procedures to properly record title in the relevant county recording office.

Many states and local governments have enacted laws that impose a transfer tax (also known as a deed, stamp, or recording tax) on the sale of real estate. Some jurisdictions impose additional taxes, such as “mansion taxes,” which are based upon the selling price of residential properties. 

Title to real estate may also be transferred pursuant to the common law principle of adverse possession, in which a trespasser may claim title to another’s land, or portion thereof, if certain conditions are satisfied. The conditions, which are set by statute, and which vary by state, generally require that a trespasser occupy the property in an “open and notorious” manner for a defined period of time.

Additionally, many states have property condition disclosure laws in connection with the sale of residential properties.

A lawful and proper transfer of title to real estate is effected by first entering into a written contract of sale as most states in the US have a so called “statute of frauds”, which requires that agreements pertaining to the sale of real property be in a writing that is signed by the parties. 

It is common practice for buyers of real estate to obtain title insurance, which insures the buyer against loss in the event that the seller did not have marketable title. It also protects the buyer from incurring expenses in connection with any lien that may be recorded prior to the buyer recording the deed.

As a consequence of the coronavirus pandemic, many jurisdictions implemented new procedures to compensate for the limited availability of in-person notarisations. For example, some states have enacted laws that permit notarisations to be conducted remotely and provide for electronic filing of documents.

A contract for the purchase of commercial real estate typically provides for a due diligence period in which the prospective buyer may engage in the following activities:

  • inspection of the physical property, including an environmental inspection;
  • review of financial information pertaining to both income generated by the property and the costs of operating the property;
  • review of tenant leases (including any amendments and modifications);
  • obtaining a title search and survey;
  • review of local zoning and land-use regulations; and
  • conducting a search for any financial encumbrances, such as contractor’s liens, property tax liens, and municipal utility liens.

Sellers often require prospective buyers to sign confidentiality and non-disclosure agreements before providing the buyer with documents and financial information during the due diligence period. 

Representations and Warranties

In commercial real estate transactions, sellers generally do not make representations and warranties regarding the state of title or the condition of the property. Commercial properties are generally sold in “as is” condition. During a due diligence period, a prospective buyer typically purchases a title report to ensure that the seller has marketable title and to learn of any encumbrances affecting the property. Prospective buyers may also retain professionals, such as engineers, architects, and environmental analysts, etc, to assess the condition of the property.

In commercial real estate transactions, a seller typically makes the following representations:

  • that it has the authority to enter into the transaction without the consent, approval or waiver of any third party or governmental agency;
  • that the “rent roll” and lease schedule (usually included as exhibits to the purchase contract) are true, complete, and accurate and that there are no obligations between the owner and tenants excepts as set forth in the leases or any amendments or modifications thereto;
  • the status of litigation, if any, affecting the property or the obligations of the seller and whether notice of any pending or threatened claim or litigation has been received; and
  • that any financing affecting the property is in full force and effect and that there are no defaults with respect thereto.

When the sale of real estate involves transferring leases, the buyer generally requires the seller to obtain “estoppel certificates” from the tenants, which serve to confirm the terms and current status of the leases (which is especially important following the coronavirus pandemic in which many leases were modified) and bars the tenants from asserting any claims that contradict what is stated in such certificates. No new types of representations or warranties have emerged to specifically handle the effects of the coronavirus pandemic. 

Buyer’s Remedies Against Seller for Misrepresentations

In commercial real estate transactions, if a buyer discovers that the seller made a material misrepresentation prior to closing, then the buyer may terminate the purchase contract and seek to recover damages for costs incurred in connection with the contemplated transaction. If the buyer discovers a material misrepresentation after the closing, and if such representation survives, then the buyer will typically seek to recover damages, equitable relief, and under limited circumstances, may seek rescission of the contract. Many representations and warranties made by the seller do not survive the closing. However, the parties may negotiate for some representations and warranties to survive for a specified period, usually for no more than one year.

Representation and Warranty Insurance

In a typical commercial real estate transaction, the parties do not purchase representation and warranty insurance. Such insurance is usually acquired in large real estate investment trust (REIT) share sale transactions and in mergers and acquisitions, where the damages that may result from a misrepresentation justify the premium costs. 

Land use and tax law are two of the most important areas of law for an investor to consider when purchasing real estate. Investors need to have a comprehensive understanding of applicable regulations affecting the use and development of the property. They should also be aware of any pending or potential changes to the applicable zoning codes, such as whether an area may be “up-zoned”, meaning that future developments may be larger in scale than what is currently permitted.

It is also important to understand which tax laws apply to the investment property, how they are calculated, and if there are any “caps” on incremental increases, as tax expenditures directly affect investment returns. Investors should also consider whether the property benefitted from any deferred taxes based upon a land use exemption and whether the property, if acquired, would continue to be eligible for such exemption.

Investors should also be aware of the Tax Cuts and Jobs Act of 2017, which made changes to many provisions in the federal tax code, including changes to corporate tax rates and permitted depreciation.

Buyers of real estate can be held liable to remediate contamination that arose prior to acquiring the property, but they can take certain measures to avoid such liability. In commercial real estate transactions, buyers typically hire professionals to conduct a Phase I Environmental Site Assessment (ESA) during the due diligence period, in which the current and historical uses of the property are analysed to assess whether or not such uses may have contaminated the soil or groundwater beneath the property. In some cases, it is recommended that a Phase II ESA be conducted, in which soil and water samples are taken to be analysed for contaminants. If contamination is discovered, then the property owner is responsible for the remediation costs pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), which is the main federal statute that regulates remediation of hazardous substances that pose a threat to the environment and to public health. Conducting a Phase I ESA prior to closing can be used to comply with the requirements of CERCLA’s safe havens for bona fide prospective purchasers and innocent landowners, in which liability for remediation costs can be reduced or eliminated.

A prospective buyer can ascertain the permitted uses of a parcel of real estate by examining the property’s certificate of occupancy (or comparable instrument) and by researching the applicable zoning code and land-use regulations.

It is common for developers to enter into specific development agreements with relevant public authorities in order to facilitate a project. For example, a developer may agree to contribute to a fund to help pay for investments in public infrastructure. These agreements can help developers obtain the necessary “buy-in” from elected officials and community groups needed to proceed with a project.        

Federal, state and local governments have the right to exercise the power of “eminent domain,” which permits the government to “take” private property, provided that the property is used for a public purpose or to benefit the public. The 5th Amendment to the United States Constitution requires the government to provide “just compensation” to private property owners for the “taking” of their land. Jurisdictions differ in what qualifies as a public use.

Most states, in addition to many counties and municipalities, impose a tax on the transfer of title to real estate, which may include the transfer of long-term leasehold interests. Tax rates vary by jurisdiction and are typically calculated as a percentage of the purchase price. Generally, the selling party is responsible for paying the transfer taxes, but the parties may agree otherwise and reflect this in the contract of sale. Certain types of transfers, such as transfers made pursuant to bankruptcy proceedings, may be tax exempt. Some states also impose a transfer tax for indirect transfers, such as when there is a transfer of a controlling interest in a company that owns real property.        

While foreign investors are generally permitted to acquire real estate in the United States, the USA Patriot Act prohibits US individuals and businesses from entering into real estate transactions with certain individuals, entities, and foreign governments. The US Treasury Department’s Office of Foreign Assets Control maintains a list of such restricted parties. There are several other federal laws and regulations that apply to foreign investments in real estate, including the Foreign Investment in Real Property Tax Act, the Agriculture Foreign Investment Disclosure Act of 1978, and the Tax Equity and Fiscal Responsibility Act of 1982. These laws generally impose reporting or disclosure requirements in which foreign investors report the real estate transaction to the appropriate federal agency by submitting information returns. Additionally, some states prohibit foreign investors from purchasing land and others limit the amount of certain types of land that can be acquired.

The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) expanded the reach of the Committee on Foreign Investment in the United States (CIFUS), which is vested with the authority to prohibit foreign investments that it determines would adversely affect national security. CIFUS now has the authority to review the purchase or lease of controlling and non-controlling interests in real property acquired by foreign persons that are located in close proximity to sensitive government facilities, such as military bases and airports. If the parties to a real estate transaction believe that the transaction falls within CIFUS’s purview, then they should, but are not required to, file notice with CIFUS to seek its approval.

The commercial real estate private lending market is very large, with about USD3.7 trillion dollars in outstanding mortgage debt. The sources of capital are diverse and encompass traditional lenders, such as large financial institutions, as well as private debt funds and REITs.

Private debt funds, which lend short-term capital to potential real estate investors, are backed by private equity. Interest received from the debt is then distributed to the fund’s investors. Private debt funds grew following the 2008 financial crisis during which traditional lenders were struggling and more stringent rules were created, to apply to borrowers.

REITs are publicly traded companies set up to own and operate large commercial properties. REITs are funded through the sale of securities to investors.

Lenders typically require commercial property owners and developers to put up the property being acquired or developed as collateral on the loan. The borrower may also be required to provide a personal guarantee, meaning that the borrower will be personally responsible for the debt, if the collateral is insufficient to cover it.

Foreign lending activity is generally not restricted in the United States; foreign lenders may. however, be required to obtain licensure in the states where the lending activity occurs. Depending upon the circumstances, national security clearance may also be required.

The recording of a mortgage almost always requires the payment of mortgage fees and taxes, which varies from state to state. For example, in New York City, purchasers are required to pay an amount equal to 1.925% of the loan amount, if the loan exceeds USD500,000 (and 1.8% for smaller loans).

In order for a security interest to attach to collateral, debtor entity must enter into a security agreement with the lender and provide proof that it has clear title to the collateral. The mortgage or deed of trust must then be publicly registered where the land is located in order to establish the security interest in the real property.

When a borrower is in default of a loan secured by a mortgage on commercial property, the lender may pursue a “foreclosure” of the mortgage. The foreclosure process varies from state to state. In New York, for example, all foreclosures are judicial foreclosures (requiring a lawsuit to be commenced).

In many states, liens generally follow the “first in time, first in right” rule, meaning that whichever lien is recorded first will have priority when the funds from a foreclosure are paid. However, there are certain exceptions. For example, judgment liens typically have a lower priority than mortgage liens. Also state law may provide priority to certain types of liens, such as tax liens.

Foreclosure actions take about 15 months to be concluded.

During the coronavirus pandemic, various states placed a moratorium on evictions and foreclosure actions. However, in some states (New York, for example) these moratoriums have expired.

When there is an existing loan, a new creditor may wish to become the senior lender, which requires consent of the existing lender to “subordinate” its superior claim over the security interest. This can be accomplished by the lenders entering into a subordination agreement which defines the creditors’ respective priority over one another. While the existing lender’s taking of a junior loan position may seem disadvantageous, there are cases in which it is advantageous to do so. For example, a lender may agree to subordinate its mortgage to a construction loan if improvements are needed to make the property marketable, increasing the chances that both loans will be paid off. Some buyers even bring in new debt and acquire the existing debt on the property. The new lender then “consolidates” the two loans and “extends” them (“consolidation and extension”) over the property.

A lender holding a security interest in real estate will not be liable under federal environmental laws provided that it does not participate in the management of the property or participate in, create or make the environmental issue worse. However, the lender must seek an exemption under the Comprehensive Environmental Response and Liability Act (CERCLA).

A borrower’s insolvency does not affect the validity of a mortgage granted to secure an obligation. However, the filing of a bankruptcy petition has the immediate effect of staying the foreclosure process.

Notwithstanding the “stay,” the bankruptcy court may grant the lender relief from the automatic stay and permit it to enforce its security interest against the borrower if the creditor is able to show “cause” for the relief, such as the debtor having no equity or where the property subject to the stay is not insured. If a lender is granted relief, then the lender may exercise whatever rights it may have outside of the bankruptcy proceeding.

The Federal Reserve Board and Federal Reserve Bank of New York have recommended the selection of the Secured Overnight Financing Rate (SOFR) index to replace LIBOR. On 19 October 2022, the US Department of Housing and Urban Development (HUD) published the proposed rule for public comment. Commenters have generally been supportive of the change, indicating that SOFR will lead to lower borrowing costs for companies because it provides more accurate rates, is more stable, and is less risky and less prone to manipulation than LIBOR.

Strategic planning and zoning policies are generally formulated at the local government level. Local governments typically enact zoning codes that regulate how properties may be used and how buildings are constructed usually in terms of their bulk. So called “Bulk Provisions” generally refer to limits on the height, setback requirements and lot coverage limitations for buildings on individual parcels of land. Some localities have formal processes in which the public’s input is included in the decision-making process with respect to proposed zoning changes, disposition of government owned real estate, and site selection for capital projects (sanitation garages, fire houses, libraries, etc). Additionally, localities sometimes enact development plans to achieve specific purposes, such as enhancing public access to parkland or limiting how proximate certain types of businesses, such as bars, can be to schools or religious entities.     

Many states and local governments use model building codes maintained by the International Code Council, the largest international association of building safety professionals, to establish minimum standards that regulate the construction of new buildings and the refurbishment of existing buildings. Local jurisdictions may then enact stricter regulations than model codes provide in order to protect against known environmental hazards, such as earthquakes, or to meet stricter energy efficiency goals. Additionally, to regulate the design and appearance of buildings, local governments may designate certain properties as landmarks and certain neighbourhoods as “historic districts,” when appropriate.

Local governments typically enact zoning codes that regulate the use and bulk of individual parcels of real estate. Additionally, jurisdictions may have independent review boards or appeals boards that have authority to grant a property owner a variance or special permit to either develop or use a parcel of land in a manner that does not conform with local land-use regulations. These processes, which may involve public hearings, may be time consuming and costly, but are almost always important to the property owner.   

If a new development or refurbishment is permitted by the applicable zoning codes and regulations, then a developer may proceed “as-of-right” and third parties have no legal basis to object to the proposed development. However, if a desired development project is not permitted by the applicable land-use regulations, then a developer may apply for variances, special permits, or seek modifications to the zoning code in order to proceed. Such changes usually require public hearings in which third-parties are permitted to raise concerns or to support the proposed development. Additionally, if a developer wishes to construct a larger building than the zoning code permits, it may seek to acquire any available “air rights,” which are development rights to a specific amount of airspace above real property frequently (but not always) other than the property which is being developed. For example, in some jurisdictions, an underdeveloped property may have “air rights” that could be leased, sold, or transferred to a developer who could then use such rights to increase the size of its building.     

Decisions made by local land-use boards and legislative bodies regarding an application for permission for development or the carrying on of a designated use are generally appealable by commencing a judicial action within the appropriate locality. However, jurisdictions typically establish high standards of review on appeal, such as whether a determination was made in an arbitrary or capricious manner or whether it was “fairly debatable” and supported by substantial evidence.

It is common practice for developers to enter into agreements with local governmental authorities or agencies to facilitate the approval of proposed development projects. Agreements may provide that a developer make improvements in public transit infrastructure or create privately-owned public spaces in exchange for the right to “overbuild” the property.

Local governmental agencies generally only issue permits or certificates, which are required in order to legally occupy a building, when a completed project complies with all applicable laws and any relevant violations have been resolved. Owners that open up their buildings to the public without the necessary permits or certificates are subject to penalties established by local authorities, which may include daily fines. During construction, local building departments conduct periodic on-site inspections to ensure compliance with applicable codes and laws and may issue fines or “stop work” orders depending on the severity of any identified violation.

Real estate investments in the USA may be held in virtually any type of legally recognised business entity. Entity structuring has three main components: compliance, legal and tax. In the authors’ experience, most real estate owners or investors prefer using either a limited liability company (LLC), a “subchapter S” corporation, or a limited partnership, as their entity. What type of business entity would be best is an issue that should be explored with knowledgeable professionals such as an attorney and an accountant.


The LLC is probably the most common business entity used by real estate investors, especially for those who anticipate a long-term “buy and hold” strategy for their real estate investments. LLCs are “pass-through” entities for tax purposes, meaning that each of the owners (members) of the entity pays taxes on his, her or its share of the profits on their personal income tax returns. There is no “double taxation” of income as there is with C corporations. An LLC also offers several other advantages over other types of business entities in addition to providing its member(s) with limited personal liability protection. LLCs provide their members with more flexibility regarding how they run their businesses and make decisions. For example, LLCs can also elect to be taxed as S corporations, they offer more structural and governance flexibility than corporations, and they have minimal record-keeping, meeting and reporting requirements. LLCs provide easier marketability for their members’ interests, thus making it easier to transfer ownership of the company. Unlike S corporations, LLCs do not have any limit on the number of members they can have. LLCs also offer flexibility in the way they distribute profits to their owners, as they are not required to be distributed amongst members equally or according to the members’ percentages of ownership. 

S Corporations

S corporations are corporations that have chosen a tax status designation under subchapter “S” of the Internal Revenue Code. S corporations are well suited to investors who seek to “flip” real estate with the goal of turning a quick profit. This allows the real estate investor (or “dealer”) to avoid self-employment/social security tax on a portion of the profit earned from “flipping” real estate, as shareholders of an S corporation can split their fund classifications between income and distribution. While S corporations offer their shareholders limited personal liability and protection of their personal assets from creditors, they do not offer many of the advantages that LLCs offer. For example, S corporations are limited to having 100 shareholders and having only one class of shares of stock (although having voting and non-voting shares is permitted). This prevents an S corporation from providing investors with different shares of dividends or distribution rights. S corporations offer less flexibility than LLCs and limited partnerships in allocating income and losses, as S corporations cannot deviate from the percentage of ownership that each owner has. S corporations require more formal management structures and have stricter record-keeping requirements than LLCs and limited partnerships.

Limited and Limited Liability Partnerships

Some “high-end” commercial real estate investments are structured as limited partnerships. Limited partnerships generally consist of a general partner (GP) who is responsible for managing the partnership, and more than one limited partner (LPs) who are only passive investors that contribute capital towards purchasing the real estate, but who typically have no role in managing the business. While the GP has unlimited personal liability for the debts and other obligations of the partnership (which is why, in practice, the GP is usually a business entity having limited liability, and frequently, limited assets), LPs are not generally liable for losses or liabilities beyond the amount of the money they have invested. 

Limited liability limited partnerships (LLLPs) are a newer type of business entity and are not currently widely used. LLLPs are structured so that the general partner is shielded from personal exposure to debts of the partnership or lawsuits. However, the biggest disadvantage of the LLLP entity structure is that it is not recognised in all states; currently 31 states, plus Washington, D.C. and the US Virgin Islands, have LLLP-enabling statutes. Since LLLPs are newer, there is less legal precedent in terms of litigation, making outcomes less predictable.

While other entity types (C corporations or general partnerships) may be used for owning real estate in the USA, they are less commonly used than the types of entities discussed above.


A REIT is a company (often publicly traded), that owns, operates or finances income-producing properties, and elects REIT status. A REIT must be formed as an entity that is taxable for federal purposes as a corporation, it must be governed by directors or trustees, and its shares must be transferable. While REITS are subject to complex tax rules and regulations, they may provide significant tax advantages for their investors.

LLCs are typically formed by filing a Certificate of Formation (or Articles of Organisation), which is filed with a state’s secretary of state (or similar agency) and paying a filing fee. LLCs are governed by an Operating Agreement, which is typically a comprehensive contract amongst the members of the LLC that covers many areas including, for example, economic rights, management and governance issues, and a variety of other rights between the members, such as procedures for raising additional capital from the members, members’ rights to transfer their interest in the entity, or what happens to their interest in the event of death or permanent disability.

If the LLC has one member, the member manages the entity. If the LLC has multiple members, then the entity may grant one member “day-to-day” control over the business (the “Managing Member”), or the entity is “manager managed” where the entity is either managed by a non-member manager or by a board of directors or board of managers, that may delegate day-to-day authority to officers, as with a corporation.

Corporations, including S corporations, are typically formed by filing a Certificate of Incorporation (or Articles of Incorporation) with a state’s secretary of state (or similar agency) and paying a filing fee. Corporations are governed by a set of bylaws which provide for board election and voting procedures, as well as by a Shareholders’ Agreement, which is a comprehensive contract that describes the various rights and obligations amongst the entity’s shareholders with each other. Usually, corporations are required to hold annual meetings of shareholders and board members, although such meetings often occur more frequently than annually.

Limited partnerships are typically formed by filing a Certificate of Limited Partnership with a state’s secretary of state (or similar agency) and paying a filing fee. Limited partnerships are governed by a limited partnership agreement which outlines each partner’s roles and responsibilities, as well as how they share in the profits.

Some states have no minimum capital requirement to set up a business entity, and others require that new business entities be capitalised with a relatively small amount of capital, such as USD1,000. The authors are not aware of any minimum capital requirement relating to real estate entities. That being said, lenders and other third parties that contract with a real estate entity may impose a minimum capital requirement. Further, an entity that is not capitalised with a reasonable amount of capital may expose its owners to personal liability (or cause them to be sued), with respect to claims that are made for the debts of a limited liability entity. 

Every state has its own LLC, corporation and limited partnership statute. These laws provide certain affirmative requirements and contain “default rules” with respect to governance-related and other issues that will apply, unless the entity’s owners have provided otherwise in their governing agreements. For example, state laws may require that a certain threshold of votes be met for the entity to approve certain matters or transactions.

As stated above, LLCs provide their members with a great deal of flexibility with respect to how the entity is structured, managed and operated, whereas S corporations (and C corporations) have stricter governance requirements and offer less flexibility. In limited partnerships, the general partner(s) provides the governance and management function, while the limited partners typically have limited voting and control rights over the entity’s affairs.

The cost of forming and organising a business entity in the USA will vary from state to state depending on the state of formation, and the state(s) in which real property will be owned. When “setting up” an entity, there are typically expenses of several hundred dollars for filing required formation documents and using a filing agent. However, set-up costs will be higher in certain states, such as New York, which require that LLCs and limited partnerships publish a copy of the applicable formation document, or a notice related to the entity’s formation. This publication requirement will likely add at least several hundred dollars to the cost of “setting up” the entity.

The cost of maintaining a business entity, including the fees that accountants may charge for their services necessary to provide the information that real estate entities may require to meet annual filing requirements, similarly varies from state to state, based on the state of formation and the state in which the real property is located. Typically, states require the filing of an annual report and payment of a small filing fee to maintain the “current” status of the entity. States also often charge so called “franchise taxes” (or “privilege taxes”) for the “privilege” of doing business or owning property in the state. Annual accounting compliance costs will vary based on several factors including the type of entity being used, the entity’s income and assets, and the state in which the entity was formed and operates.

The most common arrangements to occupy and use real estate for a limited time without buying it outright include leases, ground leases, licence agreements and easements.

A lease is a contract outlining the terms under which the tenant or lessee is permitted to use and occupy the premises and providing that the landlord will receive regular payments for a specified period of time. Leases are commonly used to rent retail space or occupy an office. 

A ground lease (or land lease) is an agreement in which a tenant is permitted to develop a parcel of real property during the lease period, after which the land and all improvements are turned over to the property owner. It involves leasing land for a long period, typically between 50 and 99 years, to a tenant who will develop, construct and operate a building on the property during the term of the agreement. Ground leases are typically financed by tenants in a manner similar to how property owners utilise mortgage financing.

While a lease grants possession of real estate, a licence grants only the right to engage in specific activities, typically for a limited, and sometimes brief, duration. Examples of licences include a right granted to a vendor to sell its product(s) on the licensor’s property, a right to hold an event such as a concert on licensor’s property, or to place a vending machine thereon.

An easement is a legal right that allows the holder of the easement to use property that it does not own or possess, for a specific purpose. For example, an easement may allow a utility provider to enter onto a property in order to install electrical infrastructure. Some easements are said to “run with the land” so that they continue, or “run with the land,” upon the property’s transfer. Other easements are referred to as being “in gross,” meaning that the easement is “personal” to the holder and does not “run with the land” upon the property’s transfer.

Commercial leases generally include gross leases, net leases, percentage leases, variable leases and ground leases. Gross leases, which are typically described as either “full-service” or “modified” are primarily used for office or retail space. In a “full-service” gross lease, the tenant receives one invoice covering the base rent, utilities, insurance and tenant’s share of taxes and common area maintenance costs; and the landlord pays all such amounts to third parties, as necessary. A “modified” gross lease typically occupies the middle ground between a gross lease and a “triple net” lease, where the tenant pays base rent, utilities, and a portion of operating costs.

Triple net leases are often used for long-term tenancies for free standing commercial buildings, warehouses or industrial spaces, and are generally preferred by landlords. Under a triple net lease, the tenant is responsible for paying most if not all of the various expenses associated with the operations and maintenance of the building, and for making all non-structural repairs; and the landlord’s responsibility is usually limited to making all structural repairs.

In a “double net” lease, the tenant typically pays the landlord the base rent together with tenant’s pro rata share of real estate taxes and insurance; and the landlord is responsible for the costs of common area maintenance and making structural repairs. 

In a “single net” lease or “net lease,” the tenant pays the landlord the base rent and tenant’s pro rata share of real estate taxes; and the landlord is responsible for paying the various other building expenses and making structural repairs.

In a “percentage” lease, which may be used for a retail business, the tenant pays a lower base rent plus a percentage of gross revenues earned at the demised premises.

In a “variable lease,” the rent structure changes over time. For example, in an index lease, the base rent amount is tied to a particular “index” such as the Consumer Price Index; whereas in a “graduated lease,” the base rent increases according to a pre-determined schedule. 

In a ground lease, a tenant is permitted to develop a parcel of real property during the lease period, after which the land and all improvements are turned over to the property owner.

Whereas residential leases in the USA may be subject to some form of state or local rent regulation (such as “rent control” or “rent stabilisation” in New York City) or other regulations relating to terminations or evictions, commercial leases are freely negotiated by the parties and have virtually no restrictions beyond basic contract law. However, during the coronavirus pandemic, the federal government and many state and local governments created a “patchwork” of laws and regulations which sought to provide relief and protection to tenants, including moratoria on evictions and foreclosures.

For example, New York City passed the so called “Guaranty Law” which prevented landlords from suing individual guarantors of certain retail leases for defaults occurring between 7 March 2020, and 30 June 2021. However, on 31 March 2023, a federal court in New York invalidated the Guaranty Law as violative of the Contract Clause of the US Constitution, as the financial burden of the law was placed exclusively on landlords. Coronavirus regulations varied widely by jurisdiction and between residential and commercial tenants. As of this writing (May 2023), while virtually all such regulations have expired as the pandemic has largely subsided, many court dockets remain backlogged. 

As commercial leases in the USA may be 80 pages or even longer, it is difficult to summarise their terms here. However, four important issues are identified and discussed below.

Length of Term

Commercial leases often have a term of between five to ten years, but they may be shorter or longer. The term will vary depending on a number of factors, including, for example, the type of property being leased (eg, retail, office, hotel, warehouse), the location of the property, and the requirements of the landlord. Retail tenants, which may include franchised businesses, typically require an initial term of not less than ten years (as it is common for franchise agreements to have an initial term of ten years). Commercial tenants have no right to renew the lease unless such a right is negotiated and reflected in the lease.

Maintenance and Repair

Commercial leases typically provide that the tenant is responsible for maintaining the leased premises and performing non-structural repairs, whereas the landlord is usually responsible for making any repairs to the building’s exterior (including the roof) and structure that affect the premises. However, where a commercial property has multi-tenants, the landlord is frequently responsible for maintaining the “common areas” of the property (interior and exterior) and charging each tenant its “proportionate share” of such expenses (based on occupancy). 

Frequency of Rent Payments

Rent payments are generally paid on a monthly basis throughout the entire term of the lease, and they are usually due on the first day of each month. Most leases provide for the payment of late fees if the rent is not received by a certain date (ie, the fifth day of the month). Sometimes ground leases call for a significant “up-front” rent payment when the lease commences, followed by scheduled payments throughout the term.

Coronavirus Pandemic Issues

The coronavirus pandemic, and the mandated government shutdowns that occurred throughout the USA, caused landlords and tenants to review their leases to assess their respective rights and obligations as to paying rent. Many landlords and tenants negotiated and agreed on modifications to their leases. However, a fair amount of litigation also occurred. Generally, force majeure clauses were not helpful to tenants as many of them did not specifically include “pandemics” or “public health emergencies” as a force majeure event. Further, many force majeure provisions explicitly provided that the tenant’s obligation to pay rent was excepted from the excuse of performance afforded by such provisions. Commercial tenants were also dismayed to learn that their “business interruption” insurance policies generally did not cover coronavirus-related losses as such policies cover “property damage” and contained exclusions for lost revenues due to “viral outbreaks” or “pandemics.” Despite the pandemic causing many small businesses to default on their leases and close, and causing widespread construction delays and supply chain issues with respect to construction materials, furniture, fixtures and equipment, no standard has emerged for helping landlords and tenants allocate the financial risks caused by similar events in the future. 

Rent variation is possible over the term of a lease.

In commercial leases, base rent is negotiated prior to entering into the lease, and the lease typically contains a schedule of base rent due under the lease. As commercial leases usually have an initial term of between five and 20 years, it is not unusual for rent increases to be implemented on a percentage basis (eg, 3% of the then-applicable amount) on an annual and cumulative basis, at one or more intervals during the initial term. If the lease provides for one or more options to renew, increases to the base rent are often negotiated in advance and set forth in the lease. However, while rent increases are often determined cumulatively, on a percentage basis, over the prior amount of annual rent due, sometimes the landlord does not want to negotiate the new base rent for a renewal term (which may commence many years in the future) at the time that the lease is entered into, and requires that the new rent be “fair market” as determined prior to the effective date of the renewal period. Such lease provisions often provide that, in the event that the parties are unable to agree on the “fair market” rent, they will use a mediator to help them reach an agreement, and that if the issue is unresolved, then a neutral arbitrator will determine the “fair market” rent after reviewing both sides’ evidence. Some leases use so called “baseball arbitration” where the landlord and tenant submit their evidence, which may include an “expert’s report,” and a “number” as to what the rent should be, and the arbitrator chooses one side’s number, as opposed to choosing a “compromise” between the two numbers. This incentivises the parties to be reasonable or risk losing. 

No states in the USA charge a VAT on rent. However, certain local jurisdictions impose sales or occupancy taxes on base rents, particularly if the length of the lease exceeds a certain length of time. 

When a commercial lease is signed, the tenant is typically required to pay the first month’s rent and a security deposit. The deposit is held by the landlord as “security” in the event that the tenant defaults with respect to its financial obligations during the term of the lease, or if the tenant causes damage to the premises that has not been repaired when the tenant vacates. The amount of lease security that is required is negotiable and varies. It will often be twice or three times the monthly base rent, although it may be as much as six months’ rent. The security may be reduced over time if tenant’s rent payment history is unblemished.

In many commercial leases, the landlord is responsible for maintaining (including repairs) the property’s “common areas” (which often include parking lots and landscaping). The associated costs and expenses are paid by the tenants (in addition to their base rent) and are typically calculated on their respective proportionate shares (ie, based upon the percentage of leasable space in the building that the tenant occupies). Alternatively, some leases are structured to include the payment of these common area maintenance expenses as part of the “rent” paid by the tenant.

Most commercial leases provide that the tenant is responsible for arranging and paying for its utilities and telecommunications (other than for water, for which the landlord may bill the tenant based upon the tenant’s usage of water as read by a meter). Usually, most utility costs for the common areas of the building are billed to the tenants (in addition to the base rent), based upon their respective proportionate shares.

While landlords purchase and maintain their insurance with respect to the property, it is standard for commercial leases to require each tenant occupying a portion of the property to purchase and maintain, at its own cost and expense, specified levels and types of insurance. Where a single tenant occupies the entire property and is responsible for the various operating costs of the property, for example, under a so called “triple net” lease, the tenant, and not the landlord, is responsible for purchasing and maintaining all necessary and appropriate types of insurance. Property insurance provides protection against claims resulting from injuries and damage to people and/or property, and covers a variety of events that could cause damage to the property, subject to certain specific exclusions, such as floods or earthquakes, that may be covered under separate policies.

Commercial tenants are usually required to purchase and maintain business interruption insurance. During the coronavirus pandemic, insurers took the position that claims for business losses due to government-mandated shutdowns were not covered under their business interruption policies. Many litigations were commenced throughout the USA, but courts largely sided with insurers in interpreting the “physical damage” requirement narrowly, and upholding insurers’ decisions to disclaim coverage.   

Commercial leases typically contain a “use” clause which describes tenant’s permitted use of the premises. The scope of this clause is negotiated between the landlord and the tenant and is frequently influenced by the respective strengths of the parties. Leases usually specify certain prohibited uses or activities. Local land use and zoning laws may impose further restrictions on the tenant’s use of the premises. Retail tenants sometimes seek to negotiate an “exclusive use” provision, where the landlord agrees not to lease another premises located in the shopping mall to a competing business. Sometimes, with a strong tenant, that restriction may extend to surrounding locations also owned by the landlord.

Commercial leases typically require the tenant to obtain the landlord’s written consent before the tenant is permitted to alter or improve the demised premises. Usually, leases also require that all plans, drawings and specifications, be submitted to the landlord for its approval, and that the tenant ensures that all work be performed in a good and workmanlike manner and be free from defects. Tenants may try to negotiate that the landlord’s granting of consent will not be “unreasonably withheld, conditioned or delayed,” rather than being in the landlord’s “sole discretion.”

Residential tenancies are the most heavily regulated category of real estate. State and local laws and regulations, which may include rent regulation, mandated lease renewals, health and safety requirements (including overcrowding restrictions), vary significantly by jurisdiction. Federal, state and local laws prohibit discriminatory practices against individuals (based on sex, race, religion or national origin) in both residential and commercial leasing contexts and some jurisdictions prohibit housing discrimination on the basis of sexual orientation. Commercial leases are subject to common law (including “nuisances”), as well as a variety of regulations including, for example, building codes, zoning laws, land use regulations and health and safety laws, all of which vary by jurisdiction.

During the coronavirus pandemic, various eviction and foreclosure moratoria were put in place to protect both residential and commercial tenants. However, virtually all pandemic related regulations to assist tenants have expired. 

A tenant’s failure to pay rent, or its insolvency, will typically enable the landlord to terminate the lease and commence proceedings to evict the tenant. However, if the tenant files for federal bankruptcy protection, an “automatic stay” is triggered and all creditors of the tenant, including the landlord, are required to immediately cease all collection enforcement or eviction efforts against the tenant. Notwithstanding this, the landlord may be permitted to continue pursuing an eviction if it obtained a judgment of possession prior to tenant’s filing for bankruptcy. Under the federal bankruptcy code, the commercial tenant must choose to either assume or reject an unexpired lease. If the tenant assumes the lease, it must continue performing under the lease and must pay any amounts that are owed. If the tenant rejects the lease, the landlord is permitted to take back possession of the premises, and it may make a claim for damages as provided for in the bankruptcy code. 

Landlords typically require tenants to tender a security deposit (usually cash, but sometimes a letter of credit) in order to protect them against a tenant’s failure to meet its obligations. The amount of security deposited is often negotiated and will vary but is often twice or three times the monthly base rent. Landlords often require commercial tenants to provide a personal guaranty by one or more principals of the business to guarantee the tenant’s lease obligations. 

If a tenant “holds over” after the lease expires, the landlord can either bring a proceeding to evict the tenant, or it can acquiesce for a period of time and continue collecting rent. Commercial leases typically provide for a significantly higher “holdover rent” (eg, 1.5 times or even twice the amount of base rent). If the tenant defaults in paying the rent, the landlord will usually release to itself, an appropriate amount of the security deposit that it is holding. Sometimes a landlord requires a tenant’s principal(s) to provide a so-called “Good-Guy Guaranty” whereby the guarantor is responsible for the payment of all rent until the tenant has vacated the premises and turned it over “broom clean” to the landlord. Advance notice to landlord of tenant’s vacatur is often required.

Most leases provide that the tenant cannot assign or sublease any portion of the premises without the landlord’s prior written consent. Landlords usually condition their consent on the assignee (i) being bound by the terms of the lease, (ii) having a certain net worth, and (iii) providing a personal guaranty by its principal(s). An issue often arises as to whether or not the tenant will be released from its obligations once the assignment takes effect. Tenants often seek a modification providing that the landlord’s consent will not be “unreasonably withheld, delayed or conditioned.” Tenants may also negotiate a revision providing that the landlord’s consent is not required for certain transfers (ie, transfers between existing principals, to a principal’s family member, or to an affiliated entity). Some franchisors require their franchisees to include a provision in a lease rider indicating that the landlord will be deemed to have consented to an assignment (or sublease) of the lease to the franchisor, its affiliate, or to another franchisee.

Generally, a landlord will terminate the lease when the tenant fails to cure a default, whether monetary or otherwise. Leases may also permit either or both sides to terminate the lease if a casualty occurs to a significant portion or the entirety of the premises and it is incapable of being restored within a defined time period.

Leases do not typically have registration requirements or execution formalities (unlike other real estate documents such as deeds). Most states do not require that a lease (or memorandum of lease) be recorded as a public record. Indeed, landlords sometimes prohibit the tenant from recording the lease (or a memorandum of lease) so that the landlord can sell the property free and clear of any leases, or because the landlord does not want its lease to be publicly available.

If the landlord terminates the lease in accordance with its terms (eg, following a default that was not timely cured), the landlord may commence a court proceeding to evict the tenant. The process to evict a tenant varies widely depending on the jurisdiction and whether the tenancy is residential or commercial. (The process for commercial tenancies moves much more quickly.) While many jurisdictions passed eviction moratoriums (and sometimes even foreclosure moratoriums) during the coronavirus pandemic, virtually all such tenant protections have expired as of the writing of this article (May 2023).

No federal, state or local government has authority to terminate a lease that is entered into by private parties. However, government authorities may have a right of eminent domain which permits them to “take” property for public use where “just compensation” is paid to the owner. As such a taking would render moot any lease at the premises, leases typically provide for their termination, with no further obligations by either side, under such circumstances. The amount of time involved in such eminent domain “takings” varies by jurisdiction and depending on the type of property being taken.

There are various structures used to price construction projects. They include the following:

  • Fixed price – general contractors may agree to complete the project for a pre-determined fixed price, regardless of any additional costs or changes to the work that may occur during the work.
  • Cost-plus – under a cost-plus pricing structure, the general contractor is reimbursed for the costs of the project, plus a percentage above cost, which provides a profit. Cost-plus pricing structures are typically used when the scope of the project is unclear, or if numerous project changes are anticipated.
  • Time and materials – this structure is typically used for small projects and where the amount of work is unclear. The general contractor is paid for the actual cost of labour and materials, plus an additional fee or percentage for profit.
  • Unit price – this cost structure is typically used for projects with repetitive units of work (eg, roads or utilities). The general contractor may be paid based on a square footage or “per unit” basis.
  • Guaranteed maximum price – under this pricing structure, the general contractor agrees to be reimbursed for the actual cost of the project up to a maximum “capped” price.

Responsibility for design and construction of a project can be handled in a variety of ways, but the following methods are most typical:

  • Design-bid-build is the traditional method of construction where the owner hires an architect or engineer to design the project. General contractors then bid on the project. The lowest bidder typically wins and is responsible for completing the project according to the plans. Other factors, such as the general contractor’s reputation (good or bad) may, however, play a part in the selection process.
  • Design-build is when the owner hires a single design and construction firm to complete the project.
  • In construction manager at risk, the owner hires a construction manager to oversee the project from start to finish. The construction manager is responsible for managing the design phase. After the design phase is completed, the construction manager steps into the role of a general contractor and completes the project.
  • Integrated project delivery is an approach used in highly complex projects in which the owner, architect, general contractor and other parties work collaboratively to develop the design and construction plan.

There are various devices which can be used to manage and mitigate construction risk on a project, all of which may be subject to various legal limitations and exclusions.

Contractual indemnification provides for one party to defend, indemnify and hold harmless the other party from certain losses or damages. For example, a contractor may be contractually bound to indemnify the owner from personal injury suits by workers and subcontractors related to the contractor’s negligence.

Warranties are promises by one party to the other party regarding the quality or performance of the workmanship and materials used in the construction. For example, a contractor may warrant that its work will be free from certain defects for a period of time following the completion of the work.

Limitations of liability provisions limit the amount of damages that one party can recover from another party. For example, a typical limitation may be that the contractor’s liability for the owners lost profits or business interruption are limited.

Damage waivers typically provide for one party to agree to waive its right to recover for certain type of damages in the event of a breach of contractor or other event causing damage. For example, it is typical during the course of each stage of design and construction, for a contractor to request the owner to sign damage waivers related to work which has been completed, inspected and accepted by the owner.

Schedule-related risk is a significant issue for construction. However, there are various ways to mitigate the risk.

Construction agreements typically contain liquidated damages provisions in which the owner may receive stipulated compensation if the project is delayed and there are additional costs and expenses incurred as a result of the delay.

Parties may also build in stipulated rights to extend time frames under certain circumstances with or without additional compensation. For example, if certain unforeseen site conditions occur (eg, bad weather delaying construction), the contractor may have the right to extend its deadlines.

The parties can also avoid delays through regular reviews and updates, during which they devise contingency plans, such as reallocating resources and adjusting schedules.

Below are typical examples of additional security:

  • Performance or completion bonds are a form of surety bond that guarantees the contractor will complete the project on time. If the contractor fails to do so, then the surety company will cover additional costs required for the developer to finish the project.
  • A letter of credit is a financial instrument issued by a bank that guarantees payment to the project owner if the contractor fails in its performance. In the event of a default, the owner may draw upon the letter of credit to pay for the project’s completion, as needed.
  • Parent guarantees are provided by the contractor’s parent company (if it has one), guaranteeing the performance of the contractor.
  • Escrow accounts may be used to hold funds by a third-party escrowee until the contractor meets certain conditions or milestones, after which the funds are released to the contractor.
  • A third-party surety is a company that provides a guarantee of performance on behalf of the contractor (eg, a surety bond or letter of credit).

Contractors and designers may file “mechanics’ liens” to preserve their right to seek compensation if the owner fails to pay. In the commercial context, mechanics’ liens are typically filed by contractors who have not been paid for work related to the project. Mechanics’ liens create a “cloud on title” which appears on the public record and may impair the ability of the owner to sell, transfer or mortgage the property until the debt is paid.

A Certificate of Occupancy (COO) must be issued by the local or municipal authority before the project can be occupied and used for its intended purpose. The issuance of a COO is subject to various requirements such as an inspection or review of final plans. For example, in New York City, the construction work, plumbing, elevator (if applicable) and electrical systems must be inspected and “signed off” upon prior to the issuance of a COO.

The United States does not impose VAT on the purchase and sale of real estate. Certain jurisdictions impose a sales and use tax on commercial leases, as more fully discussed in 8.3 Municipal Taxes

In order to mitigate transfer taxes in connection with the acquisition of large real estate portfolios, a common technique is to sell equity interests in an entity that owns the real estate as opposed to transferring the real estate outright. However, this option is not available in states that impose transfer taxes on such indirect transfers of a controlling interest in an entity owning real estate. Many states and local governments impose a mortgage recording tax. The use of a consolidation, extension and modification agreement (sometimes in connection with a spreader agreement) may be used to reduce mortgage-recording taxes by giving the borrower a credit for previously paid mortgage-recording taxes and including the existing mortgage with the new financing (consolidation) rather than paying off the existing mortgage and including the amount of the prior mortgage in the new mortgage (presumably for a larger amount), on which a recording tax must be paid.

Some jurisdictions impose taxes on commercial leases. Florida imposes a state-wide sales and use tax on tenants of 5.5% on the total rent charged under a lease or licence to use commercial real property. Florida provides tax exemptions for certain types and uses of real property, such as the lease or rental of agricultural land and the lease or rental to non-profit organisations and qualifying government entities. New York City imposes a “commercial rent tax” with an effective tax rate of 3.9% on the annual or annualised gross rent of USD250,000 or more paid by certain commercial tenants located south of 96th Street in Manhattan.

There are three main types of withholding taxes that apply to foreign investors. The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), which imposes a tax on gains from the sale of real property by foreign sellers, requires that the buyer serve as a “withholding agent” to pay the tax on the seller’s behalf. A buyer is obliged to withhold 10–15% of the sales price paid to the seller, unless the seller certifies to the buyer that the seller is not a foreign person or entity or provides proof that no gain was generated from the transfer. 

Any US partnership that generates income in connection with a US trade or business (“effectively connected income” or ECI) must pay a withholding tax on any ECI that is allocated to a foreign partner. The tax withholding rate is 21% if the foreign partner is a corporation and 37% if the foreign partner is a non-corporate taxpayer. Also, a buyer of an interest in a partnership that is engaged in a US trade or business is required to withhold 10% of the purchase price paid to the foreign seller.

Foreign individuals must pay federal income tax on gains at a maximum rate of 20% if the real property was sold after a holding period of at least 12 months or a maximum rate of 37% if such property was held for less than 12 months. Foreign corporate sellers are subject to income taxes equal to 21% of the gain from the sale of the real property, regardless of how long the property was held. Foreign corporations may also be subject to a “branch profits tax” at the rate of 30% (or less, if provided in an applicable treaty) of the after-tax earnings from a US trade or business, to the extent that they are not reinvested in the US branch assets. 

The US tax code provides owners of real estate with certain tax benefits. Real estate investors are permitted to depreciate the costs of buying and improving a building (excluding the land) in order to reduce taxable income over a certain period of time. Taking such deductions, however, reduces the owner’s cost basis in the property at the time of sale.

Section 1031 of the federal tax code permits owners of real estate held for investment to defer paying capital gains tax if the proceeds from a sale are reinvested in a “like-kind” property within a specified amount of time. This tax benefit is particularly useful when selling heavily depreciated property.

The federal tax code also provides for a capital gains tax exclusion in connection with the sale of one’s primary residence. The exclusion is USD250,000 of profit for an individual, or USD500,000 of profit for married couples, filing jointly. 

Rosen Karol Salis PLLC

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Rosen Karol Salis, PLLC has been providing legal services in the franchise and real estate fields since 2005. The firm has represented franchisors, franchisees and real estate entrepreneurs in all business and legal areas, worldwide. Senior partner, Richard L. Rosen, has over 40 years of experience as a franchise lawyer, business attorney and real estate developer. Richard and the firm have won dozens of franchise awards and authored many articles. The firm authored the “Defending Franchisor Claims” chapter in Representing Franchisees, a handbook (to be published) by the American Bar Association’s Forum on Franchising.

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