For many years, the United States has been under pressure from the multi-national Financial Action Task Force and foreign governments to bring its tax fraud, anti-terrorist, and money-laundering detection facilities up to the level of other FATF countries including those countries in the European Union. In its 2020 report, the U.S. Treasury identified the risks of the laundering of illicit proceeds through real estate purchases as a main vulnerability and key action item for strengthening the Anti-Money Laundering/Countering the Financing of Terrorism framework. The Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) is charged with implementation.
The first FinCEN prong, requiring immediate attention, is its regulations under The Corporate Transparency Act (“CTA”), which require identification of individuals at the top of the ownership chain who directly or indirectly control or own 25% of small businesses, including real estate businesses. The second prong, yet to be made final, is FinCEN’s proposed “Anti-Money Laundering Regulations for Real Estate Transactions.”
- Corporate Transparency Act
Starting January 1, 2024, any newly created entity that is a corporation, a limited liability company, or that is created by the filing of a document with a secretary of state or any similar office under the law of a State or Indian tribe (“Reporting Entity”), is required to report beneficial ownership information (“BOI”) to FinCEN. This includes entities formed under the law of a foreign jurisdiction and registered to do business in the United States. Reporting is required unless one of the 23 entity-type exemptions applies. For entities created before January 1, 2024, reports must be filed before January 1, 2025. The due date for entities created on or after January 1, 2024, is 30 days after creation (but FinCEN has a proposal to change that to 90 days for 2024).
Although a great deal of additional information must be disclosed, BOI includes full names, addresses and other personal identifying information of the individual or individuals who control (directly or indirectly) the Reporting Entity and/or own (directly or indirectly) at least 25% of the Reporting Entity. It also requires scans of supporting documents, such as driver’s license or passport. Please see our previous Client Alert discussing the CTA here.
While the CTA applies across all industries, the real estate sector is expected to be particularly impacted because of typical transaction and operating structures in the industry. Real estate is often owned by a “special-” or “single-purpose entity” (“SPE”) and the SPE is owned through a chain of additional entities. Under the CTA, the SPE and every other entity in the chain of ownership will likely be Reporting Entities and consequently subject to the reporting obligations.
Exempt Entities
As outlined in detail in our previous Client Alert, there are 23 expressly exempt entities (including a “large company” exemption) (“Exempt Entities”). As distinguished from Exempt Entities, there are a handful of entities that are not currently included as Reporting Entities (herein, “Uncovered Entities”). The most likely Exempt Entity in real estate is the “large company” exemption, which is available to any entity that (a) employs more than 20 full time employees in the United States, (b) has an operating presence at a physical office within the United States; and (c) filed a Federal income tax or information return in the United States for the previous year demonstrating more than $5,000,000 in gross receipts or sales (but note this is calculated net of returns and allowances and excludes gross receipts or sales from sources outside the United States). Although many real estate holding companies have more than $5,000,000 in such gross receipts or sales, many will not meet the 20 full time employee requirement necessary to qualify for this exemption.
Uncovered Entities
Currently, entities such as common law trusts, general partnerships, sole proprietorships and associations created without a governmental filing are not included in the definition of “Reporting Company.” They are “Uncovered Entities” but not “Exempt Entities.” On the other hand, some business trusts, which include statutory trusts and so-called Massachusetts trusts, may be considered Reporting Companies by reason of their state filings. It remains unclear whether recording a common law trust or filing a d/b/a certificate for a sole proprietorship would constitute a filing triggering reporting obligation.
BOI Information of Exempt Entities and Uncovered Entities
Although both Exempt Entities and Uncovered Entities are not Reporting Entities, to the extent they directly or indirectly “control” or own 25% of Reporting Entities, information regarding both entities must be reported by those Reporting Entities. For Exempt , only the name and identifying information of the Exempt Entity (and not the BOI of its 25% owners or controlling persons) is required. Because Uncovered Entities are not Exempt Entities, it does not appear that Uncovered Entities can avail themselves of that special rule.
For trusts (which are Uncovered Entities) having the requisite ownership and/or control of Reporting Companies, the CTA explicitly identifies the following as potential controlling persons or owners of the trust and requires disclosure of their BOI: (a) a trustee of the trust or other individual (if any) with the authority to dispose of the trust assets. (b) a beneficiary who is the sole permissible recipient of income and principal from the trust; or has the right to demand a distribution of or withdraw substantially all of the assets from the trust and (c) a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust.
With respect to direct or indirect exercise of substantial control, the regulations provide that an individual may directly or indirectly exercise substantial control over a reporting company through: (a) board representation; (b) ownership or control of a majority of the voting power or voting rights of the reporting company; (c) rights associated with any financing arrangement or interest in a company; (d) control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company; (e) arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or (f) any other contract, arrangement, understanding, relationship, or otherwise. Exceptions to the disclosure obligations, however, include (i) a minor child (but the reporting company must report the required information of a parent or legal guardian of the minor child); (ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual; and (iii) an individual whose only interest in a reporting company is a future interest through a right of inheritance.
As FinCEN acquires more experience over the next two years of reporting, we expect it will provide additional clarification, such as whether or not a beneficial owner includes trust protectors, persons holding powers to veto certain trustee actions or powers to remove trustees, or distribution advisors.
- Anti-Money Laundering Regulations for Real Estate Transactions
More regulations may be on the way. We understand that FinCEN is on the verge of issuing a Notice of Proposed Rulemaking (NPRM) following up on its December 2021 Advanced Notice of Proposed Rulemaking (ANPRM), “Anti-Money Laundering Regulations for Real Estate Transactions” (“AML Regulations”). The finalization of these AML Regulations has been predicted for some time but has been delayed, perhaps by FinCEN’s busy schedule under the CTA. The ANPRM provides that the new requirements would apply to both residential and commercial real estate and to purchases by trusts and natural persons. Additionally, real estate professionals would be required to file Suspicious Activity Reports and develop internal anti money-laundering compliance programs similar to those maintained by banks and other financial institutions. This would include, for example, designation of AML compliance officers, a training program, due diligence and risk assessment procedures, and auditing. The regulations are likely to cover real estate professionals, would include title or escrow companies, real estate agents and brokers, real estate attorneys and law firms, settlement and closing agents, real estate development and investment companies, property management companies, auction houses, investment advisers, lenders, and money-service businesses. Prince Lobel will provide further details after the ANPRM is updated and finalized by the forthcoming NPRM.
Conclusion
These two regulatory schemes will have a significant impact on real estate promoters, investors and professionals. Both impose significant liability and due diligence efforts on real estate participants and advisors. The CTA applies across all industries and calls for the disclosure of BOI, for smaller businesses but it is not transaction-based. The AML Regulations are directed at the real estate industry, are transaction-based but will require substantial additional industry infrastructure going forward.
This memorandum is a summary for general information and discussion only. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. The views expressed in this newsletter are the views of the author except as otherwise noted. If you have questions, please contact C. Russel Hansen Jr. ([email protected]; 617-456-8036).