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First-Timer Primer: What To Do After Buying an Illegally Rented Property

by Shilpi Paul

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In this edition of First-Timer Primer, we look at what steps a new owner can take when they buy a property that has an illegally rented unit.

In response to a recent article outlining DC’s right of first refusal process, one of our readers had this question:

I’ve been noticing that a few houses in the area have gone up for sale while rented. The one I most recently found had a section 8 tenant. The kicker? It was a 2-unit building that needed a C of O, but didn’t have one.

What happens when you buy a house that’s being rented illegally [or has an illegally rented unit]? Is there a way to remedy the situation, or is this a scenario that should be avoided at all cost?

In general, it is rare for a home buying transaction to move forward on a house that is illegally rented, and otherwise not a smart decision given that it can be a huge pain to get the occupying tenant to move out. However, there are instances when a buyer purchases a two-unit property or a house with a basement unit that is being rented illegally, so we reached out to Joel Cohn of the Office of the Tenant Advocate to find out what to do in these instances.

First, Cohn said that regardless of the legality of the rented unit, the tenant has the right to stay under the terms of the lease. (If it is the house in question being sold, the seller also has to offer them the first right of refusal.) If the new owner wants to take over the entire property for personal use, that is their right as well, and the tenant will have 90 days to vacate.

In instances where a buyer purchases a property with illegally rented units, there is some good news: DCRA, said Cohn, usually offers something of a grace period to landlords who are not in compliance with the law. As soon as the purchaser closes on the sale of the home and has the title in hand, they can start the process of obtaining a Basic Business License and a Certificate of Occupancy, necessary for all multi-family units. (Find out how to apply for a BBL here.) The grace period also applies to long-time owners who may be uninformed of the legal process.

In addition to paying fees and registering the address, the city will likely send out an inspector to make sure that the rental unit is up to code before issuing the licenses. Here is where things could get tricky for a potential buyer. When a unit is being rented illegally, it hasn’t yet been verified as meeting certain code requirements, and may in fact be non-compliant in any number of ways. Potential owners may want to ask their home inspector to check out the unit for any code violations, and perhaps to do a bit of research to find out what exactly is required for a unit to be eligible for a Certificate of Occupancy. For example, the home will need a kitchen, a bathroom, at least two exits and a certain ceiling height. Here is a complete list of items that the inspector will check.

If the DCRA inspector does find code violations that would prohibit a Certificate of Occupancy, the agency will also give landlords a window of time to correct the problems. However, the buyer should beware that bringing the unit up to code could prove to be quite expensive. This makes it very important to determine the code compliance before getting stuck with a property that isn’t legally rentable, in a practical sense. Another potential issue may be zoning: if the unit is in a zone that does not allow multi-family housing, the new owner may not have the option of turning the unit into a legal one.

So, to answer the original question, while this is not a scenario that necessarily should be avoided at all costs, the potential buyer should undertake some due diligence before deciding to take on the task of bring a unit up to legal standards.

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This article originally published at http://dc.urbanturf.com/articles/blog/first-timer_primer_what_do_you_do_after_buying_an_illegally_rented_property/7537

17 Comments

  1. TS said at 10:47 am on Wednesday September 11, 2013:

    This happens frequently in Capitol Hill (illegal basements). We purchased such a home in 2010, and were told by both our agent and the seller’s agent at the time of sale that getting a Certificate of Occupancy for the basement would be “no big deal.” In one sense it wasn’t—the major issues (ceiling height, separate metering) were already dealt with, so we didn’t incur major expenses.

    But in another sense, it was a real pain. The process is time consuming (DCRA’s rules are confusing, there are sometimes long lead times); inspectors can be persnickety about minor details; and any necessary renovations can result in significant expense and disruption to the tenants, who might be upset with you. Moreover, your home inspector may not be able to find out certain details, such as what’s behind the walls (and therefore whether you have, e.g., proper fire separation between units). We were lucky—our tenants were planning to leave anyway, so we had contractors come in and renovate the place in their absence (dealing with all code compliance issues and also giving it a massive cosmetic facelift, which has dramatically boosted the rent we can get). But getting a unit legal often involves more than just a little bit of paperwork.

    Based on my experience, I would say that if you’re looking at a property priced somewhere between $700K and $1 million, I would be willing to pay maybe an extra $15-20K for a unit that has a certificate of occupancy (or, on the flip side, $15-20K less for a unit that doesn’t have one). That’s for a unit with no obvious problems—just to deal with the aggravation and uncertainty of the permitting process. But if there are obvious compliance hurdles (most notably ceiling height, which typically requires expensive excavation to cure), then the number has to go up.

  1. 20011 said at 12:39 pm on Wednesday September 11, 2013:

    There is no such thing as an “illegally rented” property. There are only legal rentals with written or verbal contracts.

  1. C said at 12:47 pm on Wednesday September 11, 2013:

    20011, your response makes no sense.  Yes, there are illegal rentals in DC and people who are renting them and living in them; they do no have the BBL and/or CofO.  They also may not meet code requirements.

  1. 20011 said at 1:56 pm on Wednesday September 11, 2013:

    A renter can not, by law, “illegally rent” the property. But like you just said, property owners can illegally rent spaces.

    There is a huge difference.

  1. C said at 2:36 pm on Wednesday September 11, 2013:

    20011, I figured it was pretty much a question of semantics when you put in quotes, “illegally rent”; however, the part, “There are only legal rentals with written or verbal contracts.” I don’t agree with that; all the rentals in DC are not necessarily legal (do not have BBL and/or CofO) so those units would not qualify as legal rentals.  I also think a squatter might qualify as someone who is “illegally renting” the property.

  1. smn-dc said at 3:36 pm on Wednesday September 11, 2013:

    From my personal experience and others w/1 or two rental properties here in DC, unless someone reports you/your rental to DCRA that you’re renting the unit without any proper DC paperwork, the property you have may go undetected by DCRA. We have a studio that we rented out for yrs now (that we live above) and someone (our neighbor?) reported us to DCRA—although there are probably 30-40 other similar properties/units in our neighborhood that are being rented out—without the CofO or a business license—yet we’re the only ones that were called out and reported. We had to go through the entire pain the butt process, spend more than half a day running around DCRA, paid almost $500 and had to fix some things and spend more $$ in the unit to get it to the legal standard w/the inspector coming by twice. Nosy neighbors—thank you.

  1. Scott McGillivray said at 4:05 pm on Wednesday September 11, 2013:

    we’re the only ones that were called out and reported

    You’re unit was either up to code or it wasn’t.  “Everybody else is doing it” is an excuse third-graders use.

  1. Justin S said at 4:16 pm on Wednesday September 11, 2013:

    Thanks for writing this article!

  1. Justin S said at 4:19 pm on Wednesday September 11, 2013:

    smn-dc:

    just curious… how were you paying taxes on that income if you didn’t have a BBL?

    Isn’t it your neighbors civic duty to report you? You’re not only putting the renter at risk by renting a unit that might not be up to code, but you’re also bringing down the community by failing to pay your fair share of your taxes, too!

  1. C said at 4:49 pm on Wednesday September 11, 2013:

    smn-dc: I’m not sure how someone would know whether or not a person has a BBL or CofO for a unit (is this public information)?  Anyway, the city knows that there are thousands of illegal rental units in DC.  It is possible that the city is cracking down on them, albeit maybe slowly.  Are you sure it’s a neighbor who reported you?  I’m sure there are cases where that does happen but are you sure?

  1. Illegal Landlord said at 5:07 pm on Wednesday September 11, 2013:

    It’s entirely possible—and, in fact, advisable—to report income (and deduct appropriate expenses) on an “illegal” basement rental without a C of O or a BBL.  I know this, because I’ve done it for years.  It’s one thing not to take chances with inept—or, worse yet, potentially corrupt—DC inspectors and quite another to take chances with the IRS.

  1. mona said at 5:50 pm on Wednesday September 11, 2013:

    Justin S—You don’t have to have a BBL to report rental income to the city or the IRS. Would it be smart for the city to join the taxes database with the dcra databse, sure, will it ever happen, not likely. If that ever happens the city will suddenly be able to collect a whole lot more money off unreported rental income in the city. The city would be wise just to make the process easier to get a C of O and BBL just so they could collect more money

  1. C said at 6:03 pm on Wednesday September 11, 2013:

    Illegal Landlord and mona, I think you were answering a question that Justin S raised regarding income reporting for taxes.  You both seem to address the Federal form (IRS) but what about the local taxes, where you also have to include your federal forms.  I’m guessing/assuming that one would report rental income on the federal form, so wouldn’t local DC see the rental income?

  1. mona said at 12:57 pm on Thursday September 12, 2013:

    I would never assume to do one with out doing the other. For sure if you didn’t do one the other would see and that would set off all sorts of alarms and fees and fines and trouble. Don’t even consider reporting to one without the other

  1. C said at 1:45 pm on Thursday September 12, 2013:

    Thanks, Mona.  None of this discussion applies to me.  I will admit to being surprised that the lack of willingness to go through the paperwork for a legal rental is discarded by some because (some of) the city inspectors/employees are thought to be inept/corrupt.

  1. adam said at 3:24 pm on Thursday September 12, 2013:

    “I’m guessing/assuming that one would report rental income on the federal form, so wouldn’t local DC see the rental income?”

    You’re assuming without evidence that DCOTR shares information with DCRA.  My experience with DC government is that employees with cubicles next to one another don’t communicate, much less with employees in different departments.

  1. mona said at 1:21 pm on Tuesday September 17, 2013:

    Adam - DCOTR does share info with the IRS and it flows both ways. DCOTR have info about rental income and IRS will note it hasn’t been reported on federal. IRS note that you report rental income and DCOTR will see that you aren’t.

    Anyone who decides they aren’t going to report rental income to the city because you think the employees are corrupt/inept….well you could be right on that but that argument won’t hold up in court and then those same inept and corrupt employees are now going to determine how big of a fine to hit you with to go along with your back taxes you owe

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