The Real Deal New York

When cash makes commercial deals tricky

June 01, 2010 08:41PM
By Adam Pincus

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“Is Mr. Green coming to the closing?” Years ago, a young lawyer in New York heard that question from a veteran attorney and didn’t know what to make of it. Was he asking about another lawyer, perhaps an investor?

It turns out the fellow was talking about a potentially illegal participant in a real estate transaction: cash.

While it is by no means against the law to use cash in transactions to pay brokers’ fees or even to buy buildings, it is illegal to pay cash and not report the transaction for income taxes or property transfer taxes.

Yet some real estate insiders say the use of cash has long been, and continues to be, a part of commercial real estate deals in New York City, despite the risks.

This little secret of the trade burst into the open recently during the federal trial of two former executives at drugstore chain Duane Reade. In court testimony in April, Cory Zelnik, CEO of retail brokerage Zelnik & Company, said that a decade ago, when he was a broker at Winick Realty Group, he and the company’s CEO, Jeff Winick, were paid a combined lease commission of $100,000 in cash, handed over in a briefcase. The payment was given in cash to avoid income taxes, Zelnik testified.

Neither man was charged in the federal case. However, as The Real Deal reported last month, the state agency that issues real estate licenses, the Department of State, opened an investigation into whether the two brokers should lose their licenses because of the cash payment.

Still, this was not, as they say, an isolated example. Interviews with more than a dozen brokers and lawyers turned up additional leasing and sales deals in which one side in a deal offered to pay cash with the intent of avoiding taxes. Everyone said they turn down the offers, but most acknowledged that the practice — which is often driven by investors looking to wash money from legal or illegal cash businesses — exists.

The majority said deals involving cash were extremely infrequent today, but at least one broker said it was common practice among certain buyers.

A real estate source from a firm with an investment sales practice said it received about one offer per year to pay in cash.

“We are offered commissions in cash, or our clients are offered cash, something like once a year,” the individual said.

Such offers to use cash as a method to avoid taxes are all turned down, the insider said.

Paolo Zampolli, the Italian-born model-agency founder turned real estate broker, said that earlier this year, a European client offered to pay a seller $1 million in cash through a foreign bank account on a $5 million sale.

Zampolli, co-chairman at Manhattan-based Paramount Realty Group of America, said the owner of the Soho property had purchased it four decades ago, and as such was facing a large tax on the capital gains once it was sold. So at a meeting between the parties, the buyer offered to pay $1 million overseas, implying the recorded amount would be $4 million, thus reducing the tax burden for the seller.

“The European buyer offered to pay like $1 million in Europe for [the seller] to save on the capital gains. But I immediately stepped in and said that in America this is no good and we can all go to jail,” he said.

The under-the-table deals can be structured in many ways, but they tend to follow a basic formula, whether for an investment sale or a lease transaction. Often the cash paid will be discounted from the legal amount because of the expectation that tax will not be paid.

Zelnik’s testimony in the Duane Reade trial provided an example of the use of cash in a leasing deal. Zelnik received about $25,000 and Winick about $50,000 of the $100,000 commission.

“We didn’t ask for it in cash. It was proposed to us. I believe that the number [$100,000] represented a discount of what a calculated commission would have been,” he said. “It was a discussion between Jeff [Winick] and I and the landlord, and we decided to accept it.”

Zelnik testified there were one or two more occasions, worth a total of $5,000, for which he accepted cash and did not pay taxes.

The cash payments were not in any Duane Reade locations, he said. While Zelnik admitted to not paying taxes at the time, he did not say whether Winick had paid or not, although he testified that the purpose of the cash payment was to avoid paying taxes.

Other examples, provided to The Real Deal by sources who did not want to be identified, are from the investment sales side.

In one example, an investment sales broker who had co-brokered a sale was not paid a commission on the transaction after it closed. It turned out the commission had been paid in cash and the other broker had taken the whole amount. Since it was in cash, there was no record of the transaction. Later, the individual who paid the commission ended up working out a separate payment plan with the stiffed broker.

Despite the dangers of losing a real estate license or going to jail, there are several incentives for buyers and sellers, as well as landlords and brokers, to use unreported cash in real estate transactions.

White-collar attorney Steven Feldman, a partner at law firm Herrick, Feinstein, said laws targeting money laundering affect the ability of cash businesses to deposit earnings into the banking system without creating a paper trail.

“If you generate large amounts of cash from illegal sources or without paying taxes, you want to get that cash into the legal banking system so you can use it. Among the ways to do this are real estate transactions using cash, if you can get others to accept cash. This may constitute illegal money laundering,” Feldman said in an e-mail.

“Put it this way,” another real estate attorney said, speaking of Brooklyn or Queens. “The purchasers and seller tend to be a little less sophisticated, and tend to try and cut corners in the outer boroughs.”

There are city and state agencies that track tax fraud and can sanction brokers, but little evidence of sanctions exists, according to the agencies and a review of publicly available records.

Feldman said that in addition to not reporting the transaction in order to avoid federal and local income taxes, which brokers said can be about 50 percent, sometimes cash transactions are used to illegally avoid real property transfer taxes. That tax totals about 3 percent of a property transaction.

The city’s Department of Finance audits property filings that seem to have red flags in documentation; for instance, if the sale price of a property is lower than a mortgage recorded at about the same time, it indicates that the purchase price might not be legitimate, agency spokesperson Owen Stone said.

He could not provide examples in which the city had done an investigation based on illegal cash sales, he said.

Similarly, there is little indication that brokers have been charged with any crimes or have lost their licenses in recent years. Attorneys and brokers interviewed could not provide an example of any sanctions. In addition, a review by The Real Deal of administrative hearings at the Department of State, which rules on charges against licensed professions, did not turn up any cases.

The lack of cases could either be evidence that there are few violators or that there is little incentive for a party in the transaction to notify authorities.

Chris Havens, chief executive of Creative Real Estate Group, a leasing broker specializing in Brooklyn, said he has never been offered a commission in cash — although once he was offered cash, which he turned down, to hold a property for a potential tenant — but noted that doing so would harm all parties, including the new tenant. That’s because the tenant would have no record of a broker, who is supposed to be his advocate with the landlord.

He said the danger of anyone finding out, in today’s world of gossip-promoting technologies like Twitter, should be reason enough to stay clean.

“This is a business of reputation. You have no asset other than that,” Havens said.

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