United States: FinCEN Proposal For Nonfinanced Purchases Of Residential Real Estate And Gratuitous Transfers

Highlights

• The U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) on Feb. 7, 2024, issued a Notice of Proposed Rulemaking (NPRM) proposing a new nationwide reporting obligation to be imposed on settlement agents, title insurance agents, escrow agents and attorneys to identify and report the individual beneficial owners of specified entities and trusts acquiring residential real estate through "all cash" purchases or gratuitous transfers to trusts within 30 calendar days after the date of closing. The purpose of this new transparency initiative is to combat anonymous laundering of illicit proceeds through the purchase of residential real estate.
• The NPRM describes the circumstances in which a report would be filed, who would file the report, what information would be contained in the report and when a report would be due.
• Among notable features of the NPRM: Reportable transfers would include "all cash" and nonfinancial institution-financed purchases (with no dollar threshold), as well as transfers of ownership at no value, such as a gift of an ownership interest in residential real property to a trust – the transfer of which involves a reporting person (a real estate professional), excluding transfers between individuals.

The U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) on Feb. 7, 2024, issued a Notice of Proposed Rulemaking (NPRM). The NPRM proposes a new nationwide requirement designed to identify and report the individuals who beneficially own specified entities and trusts acquiring residential real estate for which there is no financing by a financial institution. The obligation to file the reports will be imposed on settlement agents, title insurance agents, escrow agents and attorneys who will have 30 days after the closing to file the report.

The Reason for the New Reporting

The Treasury Department has long recognized the illicit finance risk posed by abuse of the U.S. real estate market. FinCEN has been concerned about the following two broad problems in this sector:

1. The use of the U.S. residential real estate market to facilitate money laundering and other illicit activity. FinCEN is aware that illicit actors often favor transfers or "all cash" sales of residential real estate that avoid scrutiny from financial institutions that have an anti-money laundering and countering the financing of Terrorism (AML/CFT) program and Suspicious Activity Report (SAR) filing requirements under the Bank Secrecy Act (BSA). FinCEN has identified these types of transfers as vulnerable to money laundering and believes that the risk of illicit activity is sufficient to require reporting. Further, money laundering through acquisition of residential real estate impacts real estate prices, making it more difficult for legitimate buyers to participate in the market and disadvantages buyers for the reason that sellers generally favor "all cash" offers due to the speed with which a sale can be closed.
2. The difficulty of determining the individuals who beneficially own entities or trusts engaged that acquire residential real estate in "all cash" or nonfinancial institution-financed transactions.

Although the beneficial ownership information reporting rule of the Corporate Transparency Act (CTA) was enacted to identify the beneficial owners of specified legal entities at a given point of time, the CTA does not collect information on the market transactions of the reporting companies. Also, the CTA does not impose a reporting obligation on trusts and does not require the identification of the beneficial owners of common law trusts unless they own or control a reporting company.

In 2016, to address its money laundering concerns, FinCEN instituted Residential Real Estate General Targeting Orders (GTOs). The GTOs were initially introduced for a few jurisdictions, but eventually were extended to cover numerous jurisdictions. The GTOs required title insurance companies to identify and report the true "beneficial owners" behind a legal entity (but not a trust) in "all cash" residential real estate acquisitions that exceeded a certain price. The GTOs were a temporary collection measure, time-limited and targeted to select metropolitan areas of the U.S.

In view of FinCEN's assessment that additional regulation of the U.S. residential real estate sector is warranted,¹ it has proposed a permanent nationwide solution to target nonfinanced purchases of residential real estate by specified entities and trusts. In essence, the proposal is aimed to combat the anonymization of illicit actors engaged in laundering their ill-gotten gains through nonfinanced purchases of residential real estate and transfers (including gifts) to specified legal entities and trusts.

The benefits FinCEN believes it will obtain are as follows: The proposal would 1) enhance the ability of FinCEN and law enforcement to investigate and prosecute money laundering through residential real estate, 2) protect U.S. economic and national security from illicit funds that result from drug trafficking, human trafficking, corruption, fraud and other crimes, 3) assist law enforcement to generate leads and support ongoing investigations, prosecutions and asset forfeitures related to money laundering and other crimes, 4) identify high-level trends in the abuse of U.S. residential real estate for purpose of money laundering and 5) deter illicit actors form storing money in U.S. residential real estate and distorting prices.

The Proposal

FinCen has proposed a reporting obligation on certain real estate professionals performing specified closing or settlement functions on nonfinanced purchases or transfers of residential real estate. A reporting person would be obligated to file a report called a Real Estate Report for reportable transfers of residential real property by a transferor to a transferee entity or transferee trust, identifying and supplying information about the reporting person, the transferor, the residential real property purchased or transferred, the transferee entity or transferee trust, the individual beneficial owners of the transferee, the individual representing the transferee and the payment.

Rationale for Proposal

FinCEN is proposing a "lite" version of a SAR to report information containing important details about a typology of transfers in the residential real estate sector that present acute illicit finance risks. The Real Estate Report would contain basic, standardized information about all relevant transactions that FinCEN believes should not be overly burdensome to reporting persons because 1) the filing would entail no risk-based judgment about when to file and no narrative assessment (similar to reports filed under the Residential Real Estate GTOs), which do not require filers to make discretionary decisions, and 2) reporting persons would be exempted from the BSA's requirements to establish a) AML/CFT programs and b) the confidentiality provisions of the BSA that apply to SARs (since the triggering criteria for the subject report – a nonfinanced transfer of residential real estate to certain legal entities and trusts – would be known to all parties).

Overview of the NPRM

What Is a Reportable Transfer?

A reportable transfer is a transfer of any ownership interest² in residential real property to a transferee entity or a transferee trust, with certain exceptions.

This alert will first address the components of a reportable transfer and then identify and explicate the exceptions, which are crafted to reflect FinCEN's intent to capture only higher-risk transfers.

What Is Residential Real Property?

The real property must be located in the U.S.,³ and the real property must constitute residential property. This includes single-family houses, townhouses, condominiums and cooperatives,⁴ as well as apartment buildings designed for one to four families or vacant or unimproved land zoned, or for which a permit has been issued, for the construction of a structure designed principally for occupancy by one to four families.

What Is an Ownership Interest in Real Property?

A deed, stock share, membership, certificate or other contractual agreement evidencing ownership.

What Is a Transfer of an Ownership Interest?

A transfer of an ownership interest encompasses both sales as well as non-sale transfers, such as gifts and transfers to trusts. The gratuitous transfer of residential real property to a trust by the settlor or grantor may be reportable (although, there is an exception for transfers occurring as a result of death).

Is There a Dollar Threshold for a Transfer of an Ownership Interest in Residential Real Property to Be Reportable?

No, there is no dollar threshold or exception for transfers above or below a set dollar value.

What Is a Transferee Entity?

The term "transferee entity" means any person other than a "transferee trust" (which is a separate category of reportable entity, defined below) and an individual.

A transferee entity encompasses a wide variety of legal vehicles, domestic or foreign, used to own property, such as a limited liability company, an association, a corporation, a partnership⁵ or an estate. Certain entities are exempted from the definition of a transferee entity.

• Important Exclusion. A transferee entity does not include an individual. A transfer would not be reportable⁶ if made directly to an individual, provided the transferred property's title is in the name of one or more individuals, with no ownership interests held by a transferee entity or a transferee trust.
• Exempted Entities. Certain entities are exempted because the government already collects information about these types of entities. These are enumerated below.

What Is a Transferee Trust?

A transferee trust (essentially a common-law trust) is any legal arrangement created when a person (generally known as a settlor or grantor) places assets under the control of a trustee for the benefit of one or more persons (each generally known as a beneficiary) or for a specified purpose. It also includes legal arrangements similar in structure or function to the above, such as a land trust, whether formed under the laws of the United States or a foreign jurisdiction. Certain trusts are exempted from the definition of a transferee trust (see below).

Note: A statutory trust is treated as a transferee entity and not a transferee trust.

What Entities and Trusts Are Exempted?

Certain entities that are highly regulated and selected trusts are exempted because these entities are less likely to be used by illicit actors to launder money through the acquisition of residential real property.

Nonprofit organizations, unregistered pooled investment vehicles and large operating companies are not exempted.

The exception for trusts is more limited and includes securities reporting issuers, trusts in which the trustee is a securities reporting issuer and subsidiaries of an exempt trust.

What Are the Exceptions to Residential Real Estate Transfers?

There are six exceptions:

1. an extension of credit to the transferee that is secured by the transferee residential real property and extended by a financial institution that has both an obligation to maintain an AML/CFT program and an obligation to report suspicious transactions.⁷

Note: Transfers financed by a private lender or the seller, neither of which has AML/CFT compliance programs and SAR filing obligations, would not be treated as a financed transfer and are reportable.

2. a grant, transfer or revocation of an easement
3. a transfer resulting from the death of an owner of residential real property (including a transfer under a will to a trust)
4. a transfer incident to divorce or dissolution of a marriage
5. a transfer to a bankruptcy estate
6. a transfer that does not involve a reporting person

Who Is a Reporting Person?

The obligation to file a Real Estate Report would generally apply to settlement agents, title insurance agents, escrow agents and attorneys. Only one real estate business⁸ would be a reporting person for any given reportable transfer and required to collect, report to FinCEN and maintain certain transactional information. The reporting person would be identified in one of two ways: either by way of a cascading reporting order or an agreement (i.e., a designation agreement).

Note: Transfers that do not involve a typical real estate-related professional as reflected in the cascade of potential reporting persons would not be captured.

What Is the Cascading Reporting Order?

The highest real estate professional in the cascade, which involves only persons engaged as a business in the provision of real estate closing and settlement services within the U.S., would have the responsibility of filing the Real Estate Report with FinCEN. The potential reporting persons would have the responsibility of evaluating the cascade and obligation of filing; however, there would be no requirement to verify that any other potential reporting person in fact filed the Real Estate Filing.⁹

First Tier:The reporting obligation would be the agent providing certain settlement services at the termination of the settlement process. If no person prepared a closing or settlement statement, the reporting obligation would apply to the person who files the deed or other instrument that transfers ownership of the residential real property.

Second Tier:If no person executes the specific settlement functions in the first tier of the cascade, the reporting obligation would then be imposed on the person who underwrites the title insurance policy associated with the real property transfer.

Third Tier:In the event that no person executes the specific settlement functions in the first tier of the cascade and no person underwrites a title insurance policy, the third tier of the cascade would require reporting by the person who disburses the greatest amount of funds in connection with residential real property transfer.

Fourth Tier:In the event that no person participates in the transfer who comes within the first three tiers of the cascade, the reporting person would be the person who prepares an evaluation of the status of the title.

Fifth Tier:If there is no person identified in the first four tiers of the cascade, the reporting obligation would be the preparer of the deed associated with the transfer. A deed is typically prepared by an attorney, but it may also be prepared by a non-attorney settlement or closing agent or by the transferee itself.

What Is a Designation Agreement?

The professionals in the reporting cascade may enter into a written "designation" agreement¹⁰ to obligate another person in the reporting cascade to be the reporting person, regardless of the tiers in which the professional is included.

What Information Is Reportable?

The primary information to be reported relates to the beneficial owners of a transferee entity or transferee trust acquiring the residential real estate. The NPRM incorporates the definitions of beneficial owner under the CTA.

• The beneficial owners of a transferee entity are the individuals who would be the beneficial owners of the transferee entity on the date of closing if the transferee entity were a reporting company under the CTA. In brief, this means the individuals who directly or indirectly 1) exercise substantial control over a transferee entity, or 2) own or control at least 25 percent of the ownership interests of a transferee entity. Both tests are detailed and expansive in their scope and application.
• The beneficial owner of a transferee trust are the individuals who fall into one or more of the following categories on the date of closing: 1) a trustee of the transferee trust, 2) an individual other than a trustee with the authority to dispose of transferee trust assets, 3) a beneficiary who is the sole permissible recipient of income and principal from the transferee trust or who has the right to demand a distribution of, or to withdraw, substantially all of the assets of the transferee trust, 4) a grantor or settlor who has the right to revoke the transferee trust or otherwise withdraw the assets of the transferee trust or 5) a beneficial owner of any legal entity or trust that holds one of the aforementioned positions.

Other identifying information required to be reported relates to the reporting person, the transferee entity or transferee trust itself, the individual representing the transferee entity or trust, the transferor; the residential real property transferred and the payments.

The specific amount of information to be collected is broad and includes detailed personal identifiable information, particularly about the beneficial owners,¹¹ as well as information about the other individuals and persons involved in the transaction, the residential property and the payments.

The proposed rule would not require reporting persons to report changes to beneficial ownership of a transferee entity or transferee trust on an ongoing basis, as would be required under the CTA because FinCEN assessed that requiring updated reports would likely represent an impractical burden to impose on a reporting person.

What to File?

A reportable transfer is reported by completing a Real Estate Report and collecting and maintaining supporting documentation.

Where to File?

The Real Estate Report is filed electronically with FinCEN.

When to File?

A reporting person is required to file a Real Estate Report no later than 30 calendar days after the closing.¹² The purpose of this abbreviated filing date is to ensure that there is no undue delay in the reporting of sensitive information about residential real estate closings and settlements.

What About Record Retention?

A reporting person must maintain a copy of any Real Estate Report they have filed and a copy of any certifications as to the identities of the beneficial owner(s) of a transferee entity or transferee trust for five years from the date of filing and keep the reports available at all times for inspection, as authorized by law.

Who Has Access to Information Contained on the Real Estate Report?

FinCEN will maintain the Real Estate on one of its BSA secure data bases. The information is accessible by authorized users, such as law enforcement, intelligence and national security but not by the public.

What Is the Proposed Effective Date of this Rule?

One year from the date the final rule is issued. A one-year effective date is intended to provide real estate professionals sufficient time to review and prepare for implementation of the rule.

Can Stakeholders Comment on the NPRM?

Yes, the proposal is in the form of an NPRM. FinCEN has requested comments to 50 specific questions and invites stakeholders to provide any other relevant comments as well. In addition, FinCEN contains an additional request for comments (11 questions) on its regulatory comments.

Holland & Knight Takeaways

• This proposal illustrates how FinCEN is expanding the scope of its CTA beneficial ownership information proposal to collect information not only identifying the individuals who own or control an entity or now a trust, but also of a transactional targeted activity– the "all cash" or nonfinancial institution finance acquisition of residential real estate.
• The inclusion of a trust and non-sale or gift transactions would require the reporting of inter vivos transfers of residential real estate to a trust, a common type of private wealth planning transaction.
• The proposal will impose a significant burden on reporting persons to become familiar with the intricacies of the evolving CTA's rules to identify the individuals who are a beneficial owner – the significant control test and the 25 percent ownership test. Fortunately, in that regard, there would be requirement for updating reports, as is the case under the CTA.
• The proposal also would require the reporting person to obtain a significant amount of information from others, to include a certification of the correctness of information obtained from the beneficial owners.
• The proposal impacts attorneys, who are within the definition of a "reporting person," Attorneys may be within the second tier of the cascade, in respect of the person who underwrites the title insurance policy (common in some jurisdictions, such as Florida), or the fifth tier of the cascade, in respect of the person who prepares the deed. By including attorneys in the group of "reporting person," FinCEN is placing attorneys in a difficult situation – query, to comply with the reporting obligation, would an attorney be forced to violate the attorney-client privilege? Model Rule 1.6(a) indicates that "a lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation or the disclosure is permitted by paragraph (b)." Paragraph (b) provides that a lawyer may reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary:...(6) to comply with other law or a court order. In fact, FinCEN is aware of that issue, see questions 19 to 22.
• The proposal may have a severe impact on foreign persons who utilize a foreign entity or trust to hold their residential real estate for privacy reasons. If this proposal were to be finalized, that no longer would be possible.
• The 30-day period is intended to provide timely information to FinCEN and is comparable to various reporting due dates under the CTA, but query is the 30-day time period too short a period for the reporting person to gather all of the requisite information?
• The subject proposal may be a prelude to comparable reporting of commercial real estate transactions. See question 50 (Do the same considerations for type of purchaser covered and professionals required to report apply to the commercial real estate sector?).

Footnotes

1 The proposal also reflects FinCEN's consideration of all public comments in response to its December 2021 Advance Notice of Proposed Rulemaking on anti-money laundering regulations for real estate transactions.

2 At least one of the new owners of residential real estate must be a "transferee entity" or "transferee trust." In other words, a transfer of residential real estate is reportable even if one or more other transferees, such as an individual, also receive an ownership interest in the same property as part of the same transaction.

3 The term "United States" is broadly defined to include any state, the District of Columbia, Indian lands, and territory or possession of the U.S.

4 Although shares of a cooperative are generally treated under state law as personal property rather than real property, FinCEN believes that the money laundering risks for residential cooperatives are similar to those of condominiums and other residential property.

5 Note: Unlike the CTA, there is no distinction between a general partnership (which is excluded from CTA coverage if no State filing is required for formation) and a limited partnership.

6 FinCEN acknowledges that illicit actors may use natural person nominees or straw purchasers to acquire real estate to obscure beneficial ownership. Notwithstanding, FinCEN is of the view that requiring the reporting of information about transfers to individuals would significantly increase the number of reports to be filed and significantly increase the burden on the real estate industry.

7 A transfer of residential real estate involving an extension of credit that is secured by the transferred property and extended by a financial institution subject to an AML/CFT program and SAR reporting obligation would not be covered by the NPRM because the lender would have due diligence and reporting obligations.

8 A reporting person is generally the employer, principal or partnership and not the individual employee, agent or partner – unless, of course, the reporting person is a sole proprietorship, in which case the individual is the reporting person.

9 Note: It is possible that a transfer of residential real estate may not involve a purchase. This could occur when the transfer is a gift or made to a trust. There may not be a closing, a settlement process or the transfer of funds through escrow. However, a transfer to a trust or gift may involve an attorney or other real estate professional who prepares or files the deed, provides title insurance or provides a title evaluation.

10 The agreement must be in writing and identify the date of the agreement, name and address of the transferor, name and address of the transferee entity or transferee trust, property, name and address of the designated reporting person, and name and agreement. All parties to the agreement would be required to retain a copy for a period of five years.

11 The transferee engaged in the nonfinanced property transfer would need to provide a certified copy of their ownership information through a form or other attestation to the completeness and accuracy of the reported information.

12 The date of closing means the date on which the transferee entity or transferee trust receives an ownership interest in residential property.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.