Problems and Patches
Chris Burti, Vice President and Legal Counsel

We often receive questions on how to deal with title problems that call for pragmatic, as well as legal, solutions. This article will deal with such issues in order to present some practical skills benefit on problems that do not frequently occur but can be vexing when they do appear.

In the first situation, the problem property is located in Chatham County; however, it is apparently very close to the Wake County line. A little over 10 years ago, the owners took out a loan secured by a Deed of Trust that was mistakenly recorded in Wake County. This mistake was noticed, and the Deed of Trust was subsequently put on record in Chatham County. However, the Wake County recording remained unaltered.

First issue: once the error was discovered, how would the Wake County Deed of Trust have been removed of record prior to satisfaction of the indebtedness? Since the property was not located in Wake County, there is no legal need for removal because it cannot constitute an encumbrance on the land. The Deed of Trust is not a cloud on the title and does not affect marketability. NCGS Sec. 47-18(a) is referred to as the Conner Act and provides that no "(i) conveyance of land, or (ii) contract to convey, or (iii) option to convey, or (iv) lease of land for more than three years shall be valid to pass any property interest as against lien creditors or purchasers for a valuable consideration from the donor, bargainor or lessor but from the time of registration thereof in the county where the land lies, or if the land is located in more than one county, then in each county where any portion of the land lies to be effective as to the land in that county." Obviously, recording in the wrong county does not provide protection under the statute. NCGS Sec. 47-20.1 is the corollary statute effective for Deeds of Trust. It requires that to "be validly registered pursuant to G.S. 47-20, a deed of trust or mortgage of real property must be registered in the county where the land lies, or if the land is located in more than one county, then the deed of trust or mortgage must be registered in each county where any portion of the land lies in order to be effective as to the land in that county." Our courts have consistently upheld our status as a "race to the courthouse" system, see Schuman v. Roger Baker and Associates, Inc., 70 N.C.App. 313, 319 S.E.2d 308.

It may be desirable to deal with the Wake County Deed of Trust in the interest of professionalism. In such a case, cancellation prior to satisfaction of the debt is not advisable since that would imply that the borrowers had paid the loan. A release deed with adequate recitals about the erroneous recording and about not constituting a release of the Chatham County Deed of Trust would clear up and correct the status very effectively.

When the Deed of Trust was paid, the documents were properly marked satisfied and sent to the Wake County Register of Deeds where it was canceled of record. Once canceled, the original Note and Deed of Trust were sent to the borrowers and are now unavailable. About 10 years later, the property had been sold and the current owners were refinancing. The certifying attorney found the Chatham County Deed of Trust still of record. The bank that made the loan secured by the Deed of Trust is now defunct. Quite fortunately, the Trustee was a local attorney still practicing law. After discussion of the problem, the Chatham County Register of Deeds suggested that the trustee be contacted to provide a Certificate of Satisfaction and Affidavit of Lost Note to correctly remove the Deed of Trust.

Second Issue: How would the Deed of Trust be removed of record in Chatham County if the Trustee had been deceased, unwilling to cancel or otherwise unable to be located? This is a much more difficult issue to resolve. The most reliable cancellation could be achieved by filing a declaratory action and securing a judicial cancellation of the Deed of Trust. This is time consuming and expensive.

The easiest method would be to record a certified copy of the Wake County instrument in Chatham County showing the cancellation by exhibition and ask the Title insurer to provide affirmative coverage against claims arising from non-satisfaction of the debt. The insurer will most likely comply because NCGS Sec. 47-31 provides that a "duly certified copy of any deed or writing required or allowed to be registered may be registered in any county without further certification pursuant to G.S. 47-14; and the registered or duly certified copy of any deed or writing that has been registered in the county where the land is situate may be given in evidence in any court of the State." The concern that this option raises is that, at some point in the future, title marketability may arise as an issue in a contract dispute and the affirmative coverage will not likely protect the insured from such matters.

The least reliable (maybe even questionable) method would be the use of NCGS Sec. 45-37(6). When the original mortgagors paid off the indebtedness they, technically, became the ‘owners’ of the note and Deed of Trust. NCGS Sec. 45-37 provides that cancellation may be made by "exhibition to the register of deeds of a certificate of satisfaction of a deed of trust, mortgage, or other instrument that has been acknowledged before an officer authorized to take acknowledgments by the owner of the note, bond, or other evidence of indebtedness secured by the deed of trust or mortgage." The certificate of satisfaction has to be accompanied by the note, if available, with an endorsement of payment and satisfaction by the owner. If it cannot be produced, an affidavit of lost note "signed by the owner of the note, bond, or other evidence of indebtedness, shall be delivered to the register of deeds in lieu of the evidence of indebtedness certifying that the debt has been satisfied and stating: (i) the date of satisfaction; (ii) that the note, bond, or other evidence of indebtedness cannot be found; and (iii) that the person signing the affidavit is the current owner of the note, bond, or other evidence of indebtedness." The statute requires that the "certificate of satisfaction shall be accompanied by the deed of trust, mortgage, or other instrument, or a copy of the instrument, for verification and indexing purposes, which shall not be recorded with the certificate." While a technical analysis of the statute seems to permit the borrower (as owner of the paid note) to cancel, the potential for fraud would normally prevent a subsequent title examiner from relying on such a cancellation. In the example cited here, the certified copy of the canceled Wake County Deed of Trust should be sufficient to satisfy those concerns.

We would like to acknowledge our gratitude to James Kilbourne of Raleigh for providing the fact situation as a suggested topic for this article. We welcome and encourage suggestions from our readers.

1031 Exchange Information: IRS Private Letter Ruling 9926045
Statewide Title, Inc.

This Letter Ruling involves an interpretation of the related person rules contained in I.R.C. §1031(f). Unlike Private Letter Ruling 9748006, the I.R.S. here concludes that §1031 treatment is allowed and that the transaction does not have federal income tax avoidance as a primary purpose.

The Taxpayer and Decedent acquired substantial timberlands (39,000 acres in approximately 120 separate parcels) for investment during the course of their marriage. Approximately one-quarter (1/4) of the acreage contains valuable "old-growth" timber. Upon their divorce, the timberlands were divided equally and title was held as co-tenants. The Decedent subsequently died, leaving the Decedent’s Estate as a tenant-in-common with the Taxpayer.

During the Decedent’s lifetime, an option was granted to Lumber Corp. to acquire his undivided one-half (1/2) interest in the timberlands. Lumber Corp. (and its wholly owned subsidiaries) is in the business of owning and managing timberlands, harvesting timber, and manufacturing and selling wood products. Lumber Corp. intends to exercise its option. Naturally, Lumber Corp. desires to harvest the "old-growth" timber and the Taxpayer desires to hold such property indefinitely for investment.

The Taxpayer and Lumber Corp. want to exchange undivided interests in the "old-growth" timber parcels so that each will own 100% interests in half of the parcels. The remainder of the timberlands will continue to be jointly owned.

Lumber Corp. is a related person to the Taxpayer under §1031(f)(3) since the Taxpayer and Son (son of the Taxpayer and Decedent) own all of its voting common stock and a majority of its non-voting common stock is either owned by the Taxpayer, Son or Son’s trust for the benefit of his children.

The I.R.S. first finds that §1031 is applicable to undivided interests being exchanged (Revenue Ruling 79-44 and Revenue Ruling 73-476) and that timberlands may be exchanged (Revenue Ruling 72-515). Next, a review of the related person rules of §1031(f) is conducted setting forth the 2-year hold requirement for subsequent dispositions of the property received by (or from) the related person in the exchange. Exceptions to the 2-year hold requirement exist in §1031(f)(2) and include transfers (A) resulting from death, (B) due to an involuntary conversion or "(C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one or its principal purposes the avoidance of Federal income tax."

The main concern for the Taxpayer is (1) whether the harvesting of the "old-growth" time by Lumber Corp. from the property she formerly owned is subject to the 2-year hold requirement or (2) if the exception contained in §1031(f)(2)(C) for non-tax avoidance purposes is applicable. In resolving this concern, the I.R.S. finds in the legislative history of §1031(f)(2)(C) instances which are identified as non-tax avoidance transactions, including exchanges of undivided interests which result in the parties owning a single property or a larger undivided interest in some of the properties. Accordingly, the I.R.S. rules that the harvesting of the "old-growth" timber by Lumber Corp. will not constitute a disposition for the purposes of §1031(f)(1)(C) and that no gain to the Taxpayer will be triggered upon such harvest.

A comparison to Private Letter Ruling 9748006, where the I.R.S. found that tax avoidance exception contained in §1031(f)(4) overrode the 2-year hold requirement under its factual situation, is natural. In this instance, ample reasonable business motivations seem to be present to justify the untangling of the interests of the Taxpayer and Lumber Corp. After the exchange, The Taxpayer appears to own essentially what she owned before the exchange (only without co-owner). No evidence of a basis shift within the economic family unit appears to be present either; no low basis property is being sold to a third party instead of a high basis property. In Private Letter Ruling 9748006, ignoring standard exchange practices, the I.R.S. viewed the involvement of a qualified intermediary as evidence of tax avoidance purpose for the transaction as a whole and, therefore, not within the §1031.