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Posted: September 27, 2011

Colorado’s transfer fee prohibition

It might have big implications for builders, developers, non-profits

Rebecca Dow and Erik Lemmon

In May, Gov. John Hickenlooper signed into law a bill that might have unforeseen consequences for builders and developers of residential property and for non-profit foundations. The law prohibits the imposition of transfer fee covenants on residential property.

Transfer fee covenants, which require payment to a third party of a percentage of the purchase price upon any sale of property burdened by the covenant, have been utilized for decades as a mechanism by which homeowner associations, non-profit foundations, builders and developers fund the costs associated with the development and use of property.

Unfortunately, the language of the statute may impair customary business arrangements and prohibit charitable foundations from collecting these necessary transfer fees to fund their operations.

The law can be traced to the origination of so-called "private transfer fees" by a company called Freehold Capital Partners. This transfer fee was 1 percent of the home price to be paid to a private third party for 99 years, and the fee did not have any meaningful relationship to the real property subject to the fee. The threat of expansion of this type of private transfer fee prompted the Colorado legislature to act.

The law provides that transfer fee covenants on residential property that are recorded on or after May 23, 2011, are not binding or enforceable against the affected property, or any subsequent owner or purchaser. In addition, any person who records a residential transfer fee covenant on or after May 23, 2011, is liable for actual damages resulting from the imposition of the transfer fee and for the reasonable fees and costs incurred to recover payment of a prohibited transfer fee or to pursue an action to declare the covenant invalid. The statute also requires that a "Notice of Transfer Fee" be recorded for transfer fee covenants perfected prior to May 23, 2011. In the event such notice is not recorded, the transfer fee is not enforceable at the time the property is conveyed or for any future conveyances.

The law exempts a number of transfer fees from its prohibition, such as transfer fees payable to governmental or quasi-governmental entities and transfer fees payable to or collected by a homeowners association or common interest community association. Transfer fees to the extent they are payable to a 501(c)(3), 501(c)(4) or 501(c)(7) non-profit foundation are also exempt, but only if the fees benefit the community on which the covenant is recorded or any adjacent or contiguous real property. Such foundation fees must support activities described as cultural, educational, charitable, affordable housing, preservation of open space, recreational, transportation, environmental, conservation or similar activities.

The statute also includes a so-called "homebuilder exemption" for recorded documents requiring payment of an amount that once paid does not bind subsequent purchasers, and it states that in no event will such amount be payable by a grantee of "residential property" upon which there are "residential improvements" (which is not limited to a completed home).

Although these exemptions are helpful for homeowners associations and governmental entities, the law will deal another blow to homebuilders and developers in a time when they are faced with what many have described as the worst real estate market since the Great Depression. For many years, land developers and builders have structured their purchase agreements to allow builders to pay the balance of the lot price when the completed home is sold.

These deals include participations, lot premiums and deferred purchase prices. At a time when commercial real estate lending is at an all-time low, these agreements have unfortunately been swept into the prohibitions of the law. For example, the previously-described "homebuilder exemption" does not exempt unrecorded agreements between developers and homebuilders requiring payment by the builder when the completed home is sold.

In addition, foundations often impose transfer fees as a means to fund their charitable activities. The Internal Revenue Service rules regarding these organizations require that they provide a "public function." However, the law only exempts transfers fees paid to a tax-exempt entity if such fees benefit the affected real property, its community or the adjacent or contiguous property (along with supporting activities) - and not the "public."

Thus, the IRS requirements for these organizations to maintain their tax exempt status and the law directly conflict. Furthermore, collection of transfer fees to pay for the charitable organization's administrative functions appear not to be allowed, nor may the transfer fees be used to benefit more than the burdened property and adjacent land. Yet many foundations use such fees to fund their activities on a broader, state-wide basis - such as non-profit homeless shelter providers and conservation easement trusts.

The law may have prohibited the Freehold-type of private transfer fees, but also may have left homebuilders, developers and non-profit foundations without a much-needed source of funding. It is hoped that the Colorado legislature will remedy the above-described deficiencies in the law during the next legislative session. In the meantime, all entities that utilize transfer fee covenants would be well advised to seek counsel about the implications of the law's prohibition.
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Rebecca Dow and Erik Lemmon are attorneys with Holland & Hart.

Ms. Dow has more than 25 years of experience in nearly all aspects of commercial real estate, including large, master-planned development projects, acquisitions, subdivision and entitlement work, and virtually all aspects of residential home building. She can be reached at 303-295-8413 or rdow@hollandhart.com.

Mr. Lemmon's practice focuses on commercial real estate development and financing, including master-planned developments, sales and acquisitions, title matters, land use, loan documentation and leasing. He can be reached at 303-295-8086 or evlemmon@hollandhart.com.

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