M-1 records his deed of trust. It states that M-1 agrees that M-1’s deed of trust shall be subordinate to any future deed of trust provided that the proceeds secured by that future deed of trust are used to construct improvements upon the land encumbered. M-1’s deed of trust might or might not go on to state that M-1 will execute any additional documents required. The title insurer is asked to insure M-2’s deed of trust priority over M-1’s deed of trust by virtue of the subordination.

When the title examiner finds such a subordination, the examiner should exercise extreme caution. The title examiner should list M-1’s deed of trust in his opinion and should attach a copy of the subordination language for the title insurer to review prior to closing.

Most title insurers will be concerned about the above subordination for several reasons. First, the subordination is "automatic" or "self executing." This means that the subordination does not expressly reference an existent deed of trust to which M-1 is subordinating. Second, the subordination is "conditional." This means that the subordination is effective, if at all, only if the proceeds are used as specified in the subordination. An "automatic" or "self executing" subordination might be valid, depending upon its terms under the rule of MCB Limited v. McGowan, 86 N.C. App 607, 359 S.E. 2d 50 (1987). But a conditional subordination, if otherwise valid, will entitle the title insurer to take an exception to the conditions in M-1’s subordination agreement. Another important case involving the difficulties of subordinations is National Mortgage Corp. v. American Title Insurance Company, 299 N.C. 369, 261 S.E. 2d 844 (1980). This case involves an automatic and conditional subordination.

Subordination (1) of one deed of trust or lien to another deed of trust or lien; (2) of condominium declaration liens or "PUD" declaration liens to a deed of trust; or (3) of a fee to a tenant’s mortgage to a lender should be reported to and be reviewed by the title insurer prior to closing. This should eliminate the title examiner assuming unwanted liability for the pitfalls involved in subordinations.

12 U.S.C. Sec. 1823(e) applies when the FDIC or RTC is involved. It provides that no agreement, which can include a subordination agreement, is valid against the FDIC or RTC unless it is in writing, was approved by the failed depository institution’s board of directors or its loan committee as reflected in the minutes and is an official record of the depository institution. 12 U.S.C. Sec. 1823(e)(1)(B) says the agreement must be executed by the depository institution and any party "claiming an adverse interest thereunder." The quoted language has been interpreted not to include the lender to whom the depository institution is subordinating.

You can expect to see a commitment requirement similar to the following in regard to a subordination of one lien to another: "Proper execution and recordation of valid unconditional subordination of [ insert reference to lien being subordinated ] to the lien of the deed of trust to be insured. The Company must be given a copy of the subordination agreement."

Our position is that, in a deed of trust, the beneficiary lender subordinating its lien, but not the trustee, needs to sign the subordination agreement.

The commitment for a loan policy should list the lien to be subordinated to the deed of trust to be insured and the subordination agreement under "subordinate matters," with blanks left for recording data. The policy should list the completed reference under subordinate matters. An exception should be taken to the subordinated deed of trust and the subordination in the owner’s policy and commitment for the owner’s policy. This will be of some value when the prior policy is used as a "starter" for "tacking."

For additional reading material, see E. Urban North Carolina Real Property Mechanics’ Liens and Future Advances, Including Title Insurance, Sec. 51-2 (Harrison Co. 1989); E. Urban and G. Whitney, North Carolina Real Estate, Sec. 21-80 (Harrison Co. 1996).

1. General comments

In order for the taxpayer to fully defer his gain on the sale of "relinquished property" the "replacement property" must have a fair market value equal to or greater than the relinquished property value and the taxpayer must use all of his equity to acquire the replacement property. To the extent the taxpayer receives money or other property, he will have "recognized gain." This is commonly called "boot."

2. Examples of "boot netting" rules

In the examples, "T" stands for "taxpayer" selling the relinquished property and replacing it with replacement property within the 180 day replacement period in I.R.C. Sec. 1031.

(a) Rule 1: Cash received on disposition of relinquished property is offset by cash paid on acquisition of replacement property.

Example 1: T transfers relinquished property with fair market value of $100,000.00 and acquires replacement property with a fair market value of $100,000.00. All cash is used to acquire the replacement property. There is no boot and T fully defers his gain.

(b) Rule 2: Debt relief on the disposition of relinquished property is offset by cash paid on the acquisition of replacement property.

Example 2: T transfers relinquished property with a fair market value of $100,000.00 and acquires replacement property with a fair market value of $100,000.00. T is relieved of a $30,000.00 liability on T’s relinquished property. T acquires replacement property with $70,000.00 cash and adds an additional $30,000.00. T does not assume a new liability on the acquisition of replacement property. T fully defers his gain. T does not receive boot.

(c) Rule 3: Debt relief on the disposition of relinquished property is offset by debt assumed on the acquisition of replacement property.

Example 3: T transfers relinquished property with a fair market value of $100,000.00 and acquires replacement property with a fair market value of $100,000.00. T is relieved of a $30,000.00 liability on his relinquished property. T acquires replacement property with $70,000.00 cash and assumes a $30,000.00 liability. T fully defers T’s gain. T does not receive boot.

(d) Rule 4: Cash received on the disposition of relinquished property is not offset by debt assumed on the acquisition of replacement property.

Example 4: T transfers relinquished property with a fair market value of $100,000.00 and acquires replacement property with a fair market value of $100,000.00. T is relieved of a $30,000.00 liability on T’s relinquished property. T assumes a $40,000.00 liability on the acquisition of replacement property. $60,000.00 cash is used for acquisition of replacement property, leaving T with $10,000.00 in cash from the relinquished property T did not use. T has recognized gain, or boot, in the amount of $10,000.00.

Did you know a form 1099-S is required if it involves any of the following sales?

1. Improved or unimproved land. Air space is included.

2. Permanent structures, including any residential, commercial or industrial building.

3. A condominium unit and its appurtenant common elements.

4. Planned unit developments.

5. Stock in a cooperative housing corporation.

Statewide Title, Inc. has 1099-S reporting for attorneys. Here is how it works:

(1) Fill out the 1099-S Real Estate Transaction form at closing.

(2) Submit a copy to Statewide Title, Inc. Statewide Title will be responsible for filing the information electronically with the IRS.

(3) Give a copy to the seller who will use the form for tax return preparation purposes.

(4) Retain a copy on file.

The Statewide Title 1099-S Real Estate Transaction forms and detailed instructions have been designed to simplify the process and can be ordered from Statewide Title, Inc.

Call (704) 637-1027 or (800) 821-5414. Ask for the 1099-S Servicing Department when ordering. Our marketing reps will be explaining our new 1099 service to you soon. If you have any questions about our 1099 services, please call.