On February 7, 2024, the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) released a proposed rule to extend anti-money laundering (AML) safeguards to professionals in the U.S.’s residential real estate market. This proposed rule prompts a review of money laundering, how it is perpetuated in the real estate sector, and the implications of the new proposed rule.

Money laundering

Money laundering is the process of disguising illegally obtained financial assets from illicit activities such as corruption, embezzlement, and drug trafficking into funds that appear legitimate, allowing the funds to be used without detection of the illegal activity. The act of laundering money includes three stages: placement, layering, and integration. The placement stage introduces the illegally obtained funds into the financial system or legitimate commerce. The layering stage separates the money from the source by funneling it through multiple financial transactions in an effort to create confusion and distance the funds from its original criminal origin. The integration stage reintroduces the money into the economy by making it appear that the funds came from a legitimate source. This is typically done by combining the illegally obtained funds with legally obtained funds or providing a credible source for the funds.

AML laws and regulations are intended to make it difficult to use the funds obtained from illegal activities. However, AML laws and regulations generally target financial institutions and regulated industries that move money, leaving the real estate sector vulnerable.

Money laundering in the real estate sector

The real estate sector is an attractive space for money laundering as large sums of money can be moved in a single transaction and the price of real estate can be easily manipulated. It is estimated that more than $2.3 billion has been laundered through U.S. real estate by corrupt officials, drug trafficking organizations, and other criminals.

Common schemes to launder money through real estate include:

• Purchasing property with cash;
• Conspiring with other parties in the purchase;
• Purchasing properties through shell companies; and
• Renovating or “flipping” properties.

Purchasing properties with cash

Purchasing properties with cash avoids the extension of credit secured by the property by a financial institution. AML laws and regulations require that financial institutions maintain an AML program and report suspicious transactions; therefore, if the financial institutions are bypassed, the risk of money laundering increases as there are no safeguards in place to report suspicious activity.

Conspiring with other players in the purchase

Besides the seller and purchaser of properties, real estate players include attorneys, real estate agents, investment advisers, and financial institution employees. These real estate professionals can be involved in the money laundering scheme by turning a blind eye or by willful participation. They can assist in hiding the source of funds for a real estate purchase, manipulating the price, bypassing requirements, or adjusting information for the benefit of the money launderer. They also add a layer of distance between the money launderer and the real estate transaction. The U.S. remains one of only seven major industrial countries that does not require real estate professionals to comply with AML laws and regulations.

Purchasing properties through shell companies

A shell company is a front business that lacks active operations and significant assets. As shell companies are legal entities, they can conduct business through their name, hiding the true identity of the individual behind it. Purchasing a property with a shell company masks the true buyer and origin of the funds, thus adding distance between the illegal funds and the purchased asset.

Renovating properties

Money laundering through renovating properties involves paying cash to vendors for property improvements. The cash is accepted by the vendor for legitimate services and the source of the funds are not typically scrutinized as they flow through a legitimate business. The capital improvements to the property, paid for with illegal funds, increase the value of the property which will be recognized when the property is sold at a gain thus allowing the illegal funds to run through the financial system and appear legal.

FinCEN’s proposed rule

The Department of Treasury proposed the rule “Anti-Money Laundering Regulations for Residential Real Estate Transfers” to address money laundering vulnerabilities in the U.S. residential real estate sector and effectively cover cash transactions. The rule follows the Bank Secrecy Act (BSA) guidelines but streamlines the reporting process and creates a cascading list of reporting persons.

This new rule requires certain persons involved in real estate closings and settlements (e.g., settlement agents, title insurance companies, attorneys, and real estate agencies) to file reports and maintain records related to identified non-financed transfers of residential real estate to identified legal entities and trusts, including the beneficial owners of those entities and trusts. While this new rule will help alleviate the money laundering vulnerabilities in the residential real estate sector, the risks in the commercial real estate sector are still unaddressed. The commercial real estate sector should likely anticipate similar changes and reporting requirements, as the U.S. tries to combat money laundering, to be forthcoming.

In the evolving landscape of real estate regulations and the fight against money laundering, Citrin Cooperman’s Forensic and Litigation Advisory Services and Real Estate Industry Practices offer strategic guidance and support. For more information, please contact Maryann Veytsman at mveytsman@citrincooperman.com, Kaitlin Harp at kharp@citrincooperman.com, or your Citrin Cooperman advisor.