Les Scher is a practicing attorney, an expert on property deals and the author of an excellent book, Finding and Buying Your Place in the Country. Please note that this fourth (and final) extract from his work is only part of an extensive chapter on types of property ownership, which should be read in its entirety by any cooperative or other group that plans to homestead together. Excerpted by permission of Macmillan Publishing Co., Inc.from Finding and Buying Your Place in the Country, Copyright ® 1974.
Forming a Corporation to Buy Land
If you have a fairly large group that wants to purchase land together, you might consider corporate ownership. Its unique feature is that a corporation has all of the legal aspects of a single person. When a corporation is formed, each person puts in a sum of money in return for shares of stock and becomes a shareholder in the corporation. This money goes to make the down payment for the land. The shares are issued as in any other type of corporation and entitle the shareholder to live on the land and obligate him to pay assessments to the corporation to cover its costs of owning the property.
The shareholders must draw up Articles of Incorporation, bylaws, and a Shareholders’ Agreement. Each state has its own requirements regarding the proper legal form of these documents, but every state requires the filing of the articles and bylaws with the Secretary of State for approval. A filing fee is required and, in most states, an annual corporation tax.
The corporation is managed by a Board of Directors. Each shareholder can be a member of the board and thus take part in all the decision-making. The voting power of each member will depend on the number of shares of stock he owns. For simplicity, it is preferable in a large group to keep things equal. The group will specify in the bylaws the number of votes required to approve an action taken by the board. For instance, the group might decide that 75 percent of the board members must agree on any decision. The board passes resolutions authorizing its officers, including a president, vice president, secretary, and treasurer, to handle particular problems involving the land, such as paying taxes and insurance premiums, hiring someone to do road work, and paying off the mortgage. Each board member can take turns being an officer.
The Shareholders’ Agreement specifies any terms the group wants binding on the shareholders. It must be in writing, but it does not have to be filed with the Secretary of State. The agreement is a contract signed by all the shareholders which states their rights and obligations. For example, the agreement can specify that no shares can be sold or transferred by a shareholder without the approval of the board or that the use or occupancy of the land by any person other than a shareholder is prohibited unless approval is granted.
To form a corporation, it is not necessary to have an income-producing business. I have had Articles of Incorporation approved which state that “the specific business in which the corporation is primarily engaged is to own and occupy certain real property.” This type of corporation will have no income and, therefore, will be charged no federal income tax. Of course, a profit will be made when the land is sold, and a tax will be levied at that time. Although the corporation has no regular income, it will have regular expenses, such as mortgage payments, property taxes, and maintenance costs, which the individual shareholders must pay according to the terms in the Shareholders’ Agreement. Thus, the corporation operates at a loss each year.
Some states permit each shareholder to deduct from his annual personal income tax return the amount of the corporation’s net loss in proportion to the number of shares of stock he owns. Thus, the shareholder receives an annual tax benefit because the corporation “loses” money. If the shareholder lives on the land, an amount equal to the appraised rental value of the land must be subtracted from the above allowed deduction unless he can show that he is living on the land to perform duties for the corporation, such as maintenance and care of the property.
If a shareholder fails to pay his obligations as specified in the Shareholders’ Agreement, the Board of Directors can vote to sell his shares to recoup the money owed to the corporation. When a buyer is found and approved, the transfer of ownership merely necessitates changing the name of the shareholder in the corporate books instead of the usual foreclosure procedure. A reserve “slush” fund is always maintained by the corporation to use if a shareholder falls behind in his payments in order to prevent a default on the mortgage payments.
If the shareholders vote to sell the entire corporate land, the profits will be divided according to the amount of stock each shareholder owns.
An advantage of a corporation is that the shareholders do not have personal liability for the acts of the corporation, and conversely the corporation does not have liability for the acts of the individual shareholders. Thus, land owned by a corporation cannot be attached for personal debts or judgments rendered against any of its shareholders. A creditor can only attach the person’s shares in the corporation. He then becomes a shareholder and must abide by the rules of the corporation. In this way, the other landowners are protected from having their ownership disrupted by an unwelcome stranger. If the Board of Directors must approve the sale of any stock, the creditor might find it difficult to collect his money.
On the other hand, if the corporation cannot pay its debts, none of the shareholders can individually be forced to pay a creditor, although the corporation’s assets, such as its land, can be reached and sold to make up a debt. If the land is worth less than the amount of debts, the creditors cannot get a deficiency judgment against the shareholders.
The major disadvantage of a corporation is the cost involved in incorporating, since you will probably need an attorney to draw up the documents and you will have to pay state filing fees and state corporation taxes. But the corporate form of ownership has many advantages for a group that wants to own a large undivided parcel of land.
If your group plans to buy land primarily for the purpose of living on it rather than for the purpose of investment, you might see whether your state recognizes a specific corporation called the “cooperative corporation.” Under a cooperative corporation the corporate organization is seen as a “landlord” and the individual shareholding members are viewed as “tenants.” Because this arrangement is more a type of property ownership rather than a true corporation, some states have placed the cooperative corporation under the supervision of the Real Estate Commissioner rather than the Secretary of State, who normally oversees corporations. Instead of issuing shares of stock, the cooperative corporation issues a “certificate” entitling the holders to a vote in the corporation’s management and the right to live on the land. Everything else in this type of corporation is arranged in basically the same way as the profit-type corporation. Each state has its own laws on cooperatives, particularly with regard to their tax status.
The Nonprofit Corporation
Another type of corporation you might investigate if you are not planning to make money on the land is the “nonprofit corporation.” Your group must fit into one of the special nonprofit and nonpolitical categories, such as religious, educational, scientific, or charitable. If you qualify, the nonprofit corporation may not have to pay income taxes, and, in many states, will also be exempt from paying property taxes. However, you will have to maintain thorough financial records and file detailed tax returns covering the nature of your nonprofit operation.
Instead of issuing stock, the nonprofit corporation may sell or give “memberships” to the individuals, who elect a Board of Directors and vote on the operation of the corporation. Like a profit-oriented corporation, Articles of Incorporation and bylaws are required, and an additional application for nonprofit status must be made to the Internal Revenue Service and to the appropriate state agency, which determine whether the corporation is truly nonprofit and, therefore, eligible for tax exemptions.
Once formed, the nonprofit corporation remains in existence until it is “dissolved.” This dissolution process could present problems to the individual owners of the corporation because the Secretary of State or state corporations official may determine that the corporation’s assets were held in trust for the nonprofit purpose which the corporation claims to represent. This causes delays and legal problems when you try to sell the property and divide the profits among yourselves because the Secretary might attempt to prevent the profits from going to private individuals: If your group is now, or wants to become, a church or other nonprofit organization and buy land you will probably need a lawyer to get you through the legal paperwork involved in setting up the corporation in the best manner possible to meet your needs.
Forming an Unincorporated Nonprofit Association
A religious, social, educational, or other nonprofit group can also form an unincorporated nonprofit association to buy land. Although the group must appoint one of its members as a trustee who takes the title to the land in his name, the organization, rather than the trustee or other members of the group, retains liability for its own debts. The trustee only acts according to the charter and bylaws of the organization.
In a nonprofit association, no single person owns any part of the land. The members of the group usually agree to pay rent to the association for living on the land, which can be used by the association to pay its mortgage and other expenses without making a profit. This type of purchase appeals primarily to communes, ecological groups interested in preserving open space, and people interested in forming some type of community in the country without actually being personal landowners.
Arrangements must be made in writing at the time the association is formed as to how the funds from a future sale of the property will be disbursed. Each state has its own rules regarding the formation of an unincorporated nonprofit association, and you can get all the necessary information from your Secretary of State or Commissioner of Corporations. Forming such an association is usually easy and you may not require the services of an attorney. Associations are easier to form because the regulations for corporations are avoided.
A Model Owner’s Agreement
If you are going to buy land with other people, you should get together to discuss and write out in detail the terms of the co-ownership before making your purchase. The entire group should understand as completely as possible the intentions and desires of each person. The best of friends one year can become bitter enemies the following year over conflicts involving such things as mate switching, being a vegetarian versus being a meat eater, whether to hunt or not, nudity versus modesty, religious fervor versus atheism, or basic personality clashes. The best-intentioned people cannot possibly predict what will happen to them when they become co-owners of land, with all the responsibilities that entails, particularly if they are living in the country for the first time.
Often people who have never lived together in the city think they will automatically be able to commune together in the country. Actually, life in the country is more difficult because you must rely to a much greater extent on yourselves, not only for the basic necessities of survival, such as providing water, heat, shelter, but also for more subtle psychological reinforcements. The distractions of the city, which help relieve the pressures of living and working together with the same people day after day, are gone, and individual levels of awareness and personal conflicts are, therefore, emphasized. Although you cannot prevent problems from arising, you can eliminate basic misunderstandings and decide how to deal with potential future problems in an Owners’ Agreement.
Each buyer signs the agreement, which should state in writing all the details of the purchase, including such items as each person’s rights and obligations regarding the property and its use, the construction of improvements, future resale of the property, financing, decision-making, the sale of one person’s interest, individual personal liability, and what happens in the event of a death, divorce, separation, or insolvency.
All financial aspects of the purchase should be specified. Some people might want to live on the land year-round while others might only want to use the property as a vacation home. Are you all going to want to pay an equal share? Each person should understand what his financial obligations will entail, including mortgage payments and maintenance costs, and must be willing and able to meet them.
The group must decide how the members want to live on the land. For instance, is the group going to build one communal house and share the rest of all the land without dividing it up? Are the members of the group going to build houses on separate building sites and share the rest of the land communally? Or is the group going to divide up the entire land into proportionate sections for each person with none of the land shared by the group? Regardless of how it is done, be sure that adequate building sites exist for everyone who wants to construct his own house. Every site is not equally inviting so decide who gets what before you take title to the property.
The Model Owners’ Agreement I am including at the end of this chapter is the one my two land partners and I drew up among ourselves at the time we decided to buy land together. It covers the two basic areas required in any co-owner’s agreement. First, it details each buyer’s ownership rights and obligations, and, second, it states the rules to be observed in relating to the land. We bought as tenants-in-common with each person having an equal one-third interest in the land, and we agreed to make all decisions on the basis of a simple majority. You can use any figure you want for approval of co-owner decisions.
You should have no problem understanding the agreement. Notice how we stated the means by which we would handle potential situations. Each owner is responsible for building his or her own house and the amount of money put into the house will be returned upon the sale of the property. We provide for the possibility that one owner might want to sell his interest and get out of the agreement, in which case the remaining owners have “the right of first refusal.” We specify the terms under which the remaining owners can buy the seller’s interest, or if they decide not to buy it, that they have the right to approve a new buyer. Because we are interested in preserving the natural environment as much as possible, we have specified in great detail what we can and cannot do on the land.
You can use this agreement as a guide to your specific group needs, whether there are two or twenty of you. You can insert and omit specific clauses depending on your situation. Whatever agreement you make, it must be in writing, dated, and signed by all the owners. It is always advisable to notarize all the signatures. This is a simple and inexpensive process. The agreement should also be drawn up and signed before you buy the land so that you can iron out basic problems in advance. Some group members might come to realize that they do not see eye-to-eye with the other members on major issues and will decide to drop out of the deal before it’s too late. I have seen this happen many times. Our agreement is very formal and legal sounding, but yours can be expressed in any manner you choose. Informality or choice of language is irrelevant, as long as you express clearly and thoroughly what each individual’s rights, obligations, and expectations will be after the group takes title to the property.
Model Owner’ Agreement
This Owners’ Agreement is made this _______________ day of ______________, 19____ , by and between whereby it is agreed as follows:
1. The purpose of this Owners’ Agreement is to specify the rights and obligations of the undersigned Owners with regard to that certain real property situated in the County of ________________, State of ______________ , described as the _____________________.
2. The purpose of this Owners’ Agreement is also to specify the rules and regulations regarding the use and enjoyment of said property.
3. Each Owner shall have one vote in any decision regarding said property or any condition specified in this Agreement.
4. Each Owner shall pay an equal amount of the principal and interest on the existing mortgage; and each Owner shall pay an equal amount of the property taxes, assessments, and maintenance costs, including road repair.
5. If any Owner is in default in any obligation under the terms of this Agreement, the Owners, by a majority vote, may then sell the defaulting Owner’s interest without his or her consent after 30 days written notice to said Owner, provided that his or her interest shall be sold for the best price and upon the best terms obtainable from a person acceptable to the remaining Owners. In any such sale, the Owners may recoup from the proceeds of said sale any funds owed by the defaulting Owner.
6. In the event any Owner should desire to sell his or her interest in the said property, or in the event of a sale after default, the first opportunity for rejection shall be accorded to the remaining Owners. The option vested in the remaining Owners shall entitle them to purchase all rights and liabilities of the interest of the selling, or defaulting, Owner at a price equivalent to the total investment to date made by the selling, or defaulting, Owner in the said property, plus interest on that investment. The interest shall be computed at a rate of 5% per annum from the date of investment. The term “investment” shall include all money paid in the form of mortgage payments, including that portion of the payment which is accorded to principal and that portion of the payment which is accorded to interest.
The selling, or defaulting, Owner shall also be entitled to reimbursement for his or her portion of the investment in any improvements made on said property. The term “improvement” shall include structures, orchards and gardens, development of water systems, sewage systems, and drainage systems, and any other construction or development on said property which increases its value for sale. For this Agreement, the term “improvements” shall also include any items which will remain on said property, such as machinery, tools, and animals. The term “investment,” with regard to improvements, shall include all money paid for the improvement. The value of an Owner’s labor shall not be included in the computation of said Owner’s investment.
The selling, or defaulting, Owner shall be entitled to all reimbursements to be paid him in a period not to exceed five years at a rate of one-fifth (1/5) of the principal amount due, or more, per year.
Reimbursements and payments to the selling, or defaulting, Owner for his portion of investment in improvements shall include interest on the money invested in the improvements from the date of the sale to the date of the reimbursement payment. There shall be no interest for investment to the date of sale.
7. Any Owner desiring to sell his or her interest as a tenant-in-common in said property shall so advise the other Owners in writing and all Owners shall use their best efforts to locate a buyer for the interest. No interest shall be sold to any person without the written consent and approval of a majority of all the Owners.
8. No Owner shall encumber or permit the encumbrance of his or her interest as a tenant-in-common of said property by any person or legal entity without the written consent of a majority of Owners.
9. No Owner may make a gift or donation of his or her interest in said property without the written approval and consent of a majority of all the Owners.
10. No Owner shall split or divide his or her interest in said property with any other persons for any reason. Should an Owner attempt to do so, such action will be interpreted as a desire to sell his or her interest in said property, and the rules of this Agreement regarding the sale of an interest shall apply.
11. In the event of the death of an Owner, the heir to his or her interest shall be bound by the terms of this Agreement.
12. This Agreement secures for each Owner the right, should he or she choose, to construct a habitation on said property. A majority approval is required with regard to the exercise of said right to the extent that the Owners may consider aesthetic, environmental, and other considerations relevant to the location and construction of said habitation.
13. Any physical alterations of said property must be approved by a majority of the Owners. “Physical alterations” shall include, among other things, the construction of any structures, such as houses, barns, garages, greenhouses, roads, dams, wells, water tanks and other forms of land development. The term “physical alteration” shall also include the cutting of any trees and vegetation and the clearing of any part of said property.
14. There must be approval by a majority of the Owners before any gas, water, or sewage pipes or electrical lines can be installed on said property from outside sources.
15. There shall be no use of pesticides, herbicides, or other poisons at any time or any place on said property without the approval of all the Owners.
16. The hunting and killing of wildlife shall be absolutely and strictly prohibited on said property at all times and during all seasons, except that killing of wildlife will be permitted for the protection of dwellings. The wildlife in the category of animals that threaten dwellings shall include mice, rats, and skunks. Under no circumstances shall bears, wildcats, deer or birds be killed. The taking of any fish from the creeks on said property shall be in accordance with state and local regulations.
17. The keeping of all domestic and farm animals shall be subject to approval by a majority of the Owners.
18. There shall be no unnecessary discharge of firearms at any time or place on said property. The term “unnecessary discharge” shall include the use of firearms for target or practice shooting.
19. If, at any time, none of the Owners is willing or able to live on said property, then the Owners will allow one or more persons to act as caretakers of said property. The caretakers must be approved by a majority of said Owners. If any caretakers operate to the dissatisfaction of the majority of Owners they shall be asked to leave. Under no circumstances may an Owner permit a non-Owner to live on said property without the approval of all Owners living on said property.
20. The entire amount of said property may be sold if approval for such sale is given by a majority of the Owners in writing. In the event the entire parcel of said property is sold, a majority of the Owners shall agree on a selling price. The Owners may hire a licensed appraiser to determine the fair market value of said property and improvements. The fees and costs of said appraisal, and the fees and costs of any other expenses involved in the selling of said property, shall be borne equally by each Owner.
21. In the event the entire parcel of said property is sold, after reimbursement of each Owner according to the terms in Paragraph 6 of this Agreement, all remaining proceeds shall be divided equally among the Owners.
22. In exercising the majority approval and vote rule of this Agreement, the Owners shall make all reasonable efforts to contact and consult with an absentee Owner and accord to him or her the right to exercise a vote whenever any matter subject to approval should arise. “Reasonable efforts” shall include, but not be limited to, special delivery letters and telegrams. Should the absentee Owner be unavailable after the expenditure of a reasonable amount of time and effort to locate him or her, then the remaining Owners shall proceed with the granting or denying of approval.
23. A majority of the Owners shall have the right to initiate legal action against any Owner who violates the terms of this Agreement.
24. If a majority of the Owners initiate any legal action against another Owner due to a violation of the terms of this Agreement, the defendant Owner shall be liable for reasonable court costs and attorney fees.
25. Any amendments or additions to this Agreement must be approved in writing by a majority of the Owners of said property.
26. This Agreement is written and approved in the spirit of fairness to all the Owners in the hope that no Owner shall derive any benefit at the unfair expense of any other Owner.
(Owner’s Signature) ___________________
(Owner’s Signature) ___________________
(Owner’s Signature) ___________________