Real Estate Transaction Basics

A real estate transaction can be a perplexing process no matter if it’s large or small. The precise procedures and professionals pushing paper appear puzzling regardless of whether the transaction qualifies for a tax-deferred exchange under Section 1031. While there are many legal and financial aspects that revolve around the purchase and sale of real estate, the closing of a real estate transaction should not be an adversarial process. No useful reason exists to think of or treat a closing like litigation although it does happen. Everyone involved needs to work together in a cooperative way to consummate the deal. Real estate law is a function of locality and custom in many respects; however, we will generally review some commonalities in the closing of a real estate transaction.

Most real estate transactions begin with a written contract and end with a closing. The following parties are typically involved in negotiating, performing and closing on the contract:

  • Seller
  • Buyer
  • Real estate agents
  • Attorneys (depending on locality and complexity)
  • Lender (if not a cash deal or other financing arrangement)
  • Title company

All agreements for the purchase and sale of real estate must be in writing. The contract sets forth the conditions under which the seller agrees to transfer and the buyer agrees to purchase the property. The contract may be lengthy or pithy, complex or straightforward, but its ultimate purpose is to convey ownership of the property to the buyer under mutually agreed upon terms.

Occasionally, a real estate transaction may involve an IRC Section 1031 tax-deferred exchange. The tax code and treasury regulations also provide certain rules that address conveying real estate in a tax deferred exchange. A qualified intermediary (QI) is generally required and is a person or entity that is not a “disqualified person” as defined under the tax code. For the most part, a disqualified person is someone who is under the control, or an agent, of the taxpayer. The QI enters into a written exchange agreement with the taxpayer pursuant to which the QI agrees to acquire and transfer both the relinquished (old) and replacement (new) properties to the taxpayer. For exchange purposes, these transfers to and from the QI can be accomplished if the party’s rights are assigned to the QI and all parties to the contract are notified in writing of the assignment on or before the closing date (see: Case Study: A Forward Exchange of Real Estate).

On the date set forth in the contract, the parties will gather at a title company office to close the transaction. One of the seller’s most basic contractual duties is to convey the marketable title to the buyer. Title is “marketable” if it covers the entire property that the seller is purporting to convey to the buyer and is free of encumbrances that a reasonable buyer would not accept. In other words, it needs to be demonstrated that the seller actually owns the real estate and has a right to transfer ownership to the buyer free from unacceptable title defects.

The seller will prove the title is marketable by way of a title commitment or title report issued by a title insurance company. A title commitment is prepared by the title company (or attorney depending on locality) based upon a title search of the public records to see which documents have been recorded against the property. It is the seller’s obligation to remove or otherwise satisfy any unacceptable conditions not agreed to in the contract that may be set forth in the title commitment. Examples of unpermitted or unacceptable title exceptions may include mortgage, tax, mechanics’ liens, encroachments or other such encumbrances.

At closing, the seller will deliver properly executed and notarized conveyance documents and other documents to the buyer and title company. Examples of such closing deliverables may include the deed, bill of sale, plat of survey, and settlement statement. Possession of the real estate is usually surrendered to the buyer at the closing.

The buyer’s principal obligation at the closing is to pay the purchase price to the seller in consideration for the property. Unless it’s a cash deal, the buyer will typically procure a mortgage loan from a lender for purposes of financing all or portion of the purchase. The buyer’s lender will have its own documents and requirements that will need to be satisfied on or before the closing in order for the buyer to obtain the loan.

Lastly, the title insurance company plays an important part in a real estate closing on behalf of all the parties. The title company will waive, insure over, or otherwise resolve all matters set forth on the title commitment. If the buyer is utilizing a lender, the title company will review the loan documents, ensure they are accurate as well as properly executed, and obtain any required information or documentation from the parties. The title company also acts as the disbursing agent for the seller and buyer. At closing, the title company will collect the purchase proceeds from the buyer and its lender (if any) and disburse the funds as set forth in the final settlement statement. After the closing has occurred, the title company will issue an owners’ policy (and loan policy if applicable) in addition to sending certain documents of record, such as the deed and mortgage, to be recorded in the County Recorder of Deeds Office where the real estate is situated.

In sum, it is advantageous to know the parties and possess a knowledge of established procedures for purposes of effectively navigating the real estate closing process. The foregoing is especially important if the transaction qualifies for a tax deferred exchange under Section 1031.