What Is Commingling in Real Estate and Is It Legal?

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Written By Justin McGill

DealBloom aims to share the latest tips and strategies to help realtors, brokers, loan officers, and investors navigate the world of real estate.

What is commingling in real estate? What are its benefits in real estate investments? Is it even legal?

What Is Commingling in Real Estate?

You may have heard of the word “commingling” before as it is often used in local waste programs.

But what is commingling in real estate?

In the real estate industry, “commingling” is the act of mixing or blending different properties or assets.

Mixing or combining funds from different sources is a common practice, but it’s important not to lose track of where those funds came from and what they’re being used for. If these funds have been earmarked for specific purposes, then they could be in violation of the law.

As a business owner, it is important to be aware of the source of your funding and to ensure that those funds are being used correctly. This is especially crucial in instances where commingling in the real estate industry could lead to legal penalties.

What Are The Benefits of Commingling?

The structure of investors putting their money into one single mutual fund has been used since the beginning of investment funds.

By commingling, a fund manager can more effectively manage investor funds. This allows them to better meet the goals of the investors.

Pooled funds are traded in blocks of 100 shares, which helps keep transaction costs down.

However, this does require fund managers to maintain certain positions in cash to account for the transactions of the commingled shareholders.

By pooling their resources and combining them, investors can achieve a specific financial objective. There are many different types, or classes, of pooled investments, such as mutual funds, ETFs, trusts, and REITs.

Keeping track of funds using basic records allows for regular reporting to stakeholders.

For mutual fund investors, daily price quotes allow an investor to track the value of their investment and see how it compares to the total managed assets of the fund. This information can help investors make decisions about when to buy or sell shares.

A commingled fund pools together money from many investors and invests it in a variety of securities.

The work required to manage a commingled fund is largely the same regardless of the size of the fund. This allows individual investors to benefit from lower fees, as they are sharing the cost of management with other investors in the pool. However, large pools of money may make it difficult for smaller investments to have a significant impact on the overall performance of the fund.

A smaller but potentially more profitable investment may be more attractive to a large investment fund. The profits can be spread among a large number of investors and this could lead to more research into the investment and greater risk being undertaken by the larger firm.

Is Commingling Legal?

Mixing up finances in the real estate industry can be a risky endeavor. Depending on state law and the situation, it may or may not be considered legally acceptable. If you’re not sure about the legality, it’s best to consult a real estate lawyer.

Mixing or combining assets is permissible when done intentionally. For instance, several people may combine their personal funds to invest in a real estate project.

Individual investors may choose to invest in a real estate investment trust (REIT) or crowdfunding project knowing that their funds will be commingled with other investors’ funds. In this type of commingling, all parties are aware of and consent to the arrangement.

This is an example of legal commingling.

When done right, real estate partnerships can be great. They allow real estate investors to:

  • Own a piece of a passive income investment
  • Invest in multiple real estate assets
  • Access to a diverse portfolio of investments than if they had invested alone
  • Find partners on projects with a larger potential for growth

While commingled funds are perfectly fine in the real estate industry, they can quickly turn bad if you are not careful.

Commingled funds most often occur through honest mistakes by real estate investors.

Here are a few examples of when commingling becomes illegal.

  • Sending deposits to a personal bank
  • Personal and business funds are deposited into the separate bank account that receives and holds the deposits of tenants’ security deposits
  • Transfer or withdraw funds from the trust fund for any reason other than a refund of a security

Why are these financial activities examples of illegal commingling? We’ll expand on this next.

Commingling in Real Estate Example

The most common form of illegal commingling is accidentally combining rental and deposit income.

When landlords rent out units to tenants, they typically collect a security deposit. This money is kept separate from any rent payments. If, however, this money is all deposited into the same bank account, this is considered illegal.

This is because a renter has entrusted their landlord with their money. The landlord must ensure that the deposit is kept safe and not used for personal expenses.

When a tenant leaves, a landlord is legally obligated to return their deposit. If the tenant caused any damage during their stay, the cost for repairs will be taken out of the deposit.

For accounting purposes, the security deposit should be listed as a liability and not income on your financial statement.

If you own any rental properties, you’re legally required to understand your state’s tenant-landlord law. In some states, you must set up a trust account for holding your tenants’ deposits.

While not every state requires it, setting up a separate account for security deposit payments is a good way to avoid any accusations of illegal commingling.

How to Avoid Commingling

To avoid mixing business and personal finances, you should consult with a real estate lawyer and take their advice to heart. Or, at the very least, keep your business money completely separate from personal expenses.

This way, you never have to worry about accidentally spending your investment fund on personal expenses.

Here are some ways to avoid mixing up real estate transactions:

  • Setting up an LLC for each of your property investments is a great way to create a clear distinction between your personal and professional finances.
  • Open a separate bank account and credit card account for each of your rental properties, and only pay each expense for each rental with its respective account and card.
  • Keep a separate trust account for security deposits and personal and business accounts
  • Never dip into business funds to pay for your personal expenses
  • Keep accurate bookkeeping records of all of your transactions, including sales, purchases, and receipts.
  • Be sure to review your income statement, balance sheet, and statement of cash flows regularly to catch any mistakes.

Conclusion

What is commingling in real estate? Commingling is a familiar term in recycling — it means mixing or blending things. In the real estate industry, commingling takes on a different nuance. By keeping your personal and business finances separate, and by tracking all of your expenses carefully, you can avoid any potential legal problems down the road.

Justin McGill