Completing Critical Paperwork
Finding a contractor to work on your rehab investment property is an important first step. Once you have found the right contractor, you must use these six (6) Critical Documents to ensure you have the legal protection you need if something goes wrong with your rehab project. These documents are for both your protection and that of your contractor.
- Independent Contractor Agreement
- Final Scope of Work
- Payment Schedule
- Insurance Indemnification Form
- The Final Lien Waiver
Some investors believe these documents are optional. We strongly advise following these guidelines and running your business as a business, not a hobby.
The first five (5) critical documents above should be given to a rehab contractor and signed and returned to you. The documents should be signed before construction begins but after you close on a property.
Important document number six (6), the last document – “The Final Lien Waiver,” should never, under any circumstances, be delivered until the contractor has finished working on the project. It is important to understand, do not sign the final document until you are satisfied with every single deliverable on a rehabbing project.
Also, before you hand over any documents, be sure to have a real estate attorney look them over, even if you’re using a template. You want to ensure you haven’t missed anything or that sections/language are outdated or apply to your specific state.
All documents should be signed and prepared before construction starts, EXCEPT for the final waiver, which is only done after all work has been completed.
NOTE: DO NOT SIGN ANY DOCUMENTS WITH YOUR CONTRACTOR UNTIL YOU’VE CLOSED ON THE PROPERTY!
Independent Contractor Agreement: This is the main binding agreement that establishes the ground rules of the proposed relationship between you and the contractor. A 1099 worker (self-employed or independent contractors) uses a 1099 form to report their income on their tax returns. W-2 workers are also known as employees, and a company employs these workers directly. They receive regular pay and employee benefits. Every small business owner should understand the difference between these classifications and when to hire a W-2 versus a 1099 worker. It is one of the most important things you can do to ensure a rehabbing project goes smoothly. This agreement will outline the significant roles and responsibilities of each party in the transaction.
This agreement covers items such as permits (the responsibility of the contractor), materials (you choose the materials; the contractor will purchase them), the use of subcontractors, work and completion schedules, the role of arbitration, and insurance.
- Final Scope of Work: This is critical because it establishes a clear project plan and costs agreed to by you and your contractor. Suppose you’ve not told your contractor precisely what work needs to be included in their bids. In that case, it leaves too much room for interpretation, resulting in change orders, conflicts, and disagreements.
- Payment Schedule: This document includes a list of milestones that need to be completed before the contractor can expect to receive payment. A good payment schedule will identify when individual projects need to be completed. Another benefit is it will/could establish a reward system for the contractor each time the proper criteria are met. In other words, the contractor will only receive payments for the work they complete to your satisfaction. In the event the agreed-upon criteria are met, they collect. With clear milestones/benchmarks, contractors are more likely to stay on schedule and complete the task at hand.
The following represents an “example” benchmark payment schedule:
First Payment: Demo and frame out (15% of the total payment)
Payment 2: Insulation, sheetrock, ceiling, trim (20% of the total payment)
Payment 3: Install kitchen and bath amenities (20% of the total payment)
Payment 4: Countertops and flooring (20% of the total payment)
Final Payment: Punch-list and final closeout (25% of the total payment)
NOTE: Investors/rehabbers are in no way exempt from the payment schedule they were responsible for creating. It is equally essential for Investors/rehabbers to pay their contractor when the agreed-upon work is completed. Implementing a transparent and reliable schedule is the surest way to keep progress forward.
- Insurance Indemnification: This stand-alone document requires the contractor to carry the appropriate insurance BEFORE beginning work on a real estate rehab project. While you should have already touched on this in the Independent Contractor Agreement, it’s important enough to warrant a stand-alone document. That said, it’s at this point that you’ll want to require the contractor to meet specific insurance requirements. Additionally, the contractor must acknowledge multiple times that they will meet the agreed-upon insurance requirements for the entire project’s duration. Some recommend requiring a contractor to carry at least $1 million in liability insurance for a frame of reference. Please see a professional Insurance company or risk advisor to see the best options and coverage to expect.
To protect yourself, include this with your packet of documents and request that your contractor provides you with the following:
- Proof of liability insurance
- Proof of workers compensation insurance
- Certificate of insurance from his carrier adding you as an additional insured and including the property address
- W-9: The Internal Revenue Service (IRS) requires that any contractor you pay more than $600 be issued a 1099 form within a calendar year. To accomplish this, you will need to have the contractor fill out a new W-9 form each year to gather information, such as a social security number or a Tax ID number.
Everyone is required to pay taxes, and real estate investors are no exception. The W-9 is an important document of a rehab that carries significant tax implications. This W-9 is also known as a Request for Taxpayer Identification Number and Certification. A W-9 enables its distributors to collect the appropriate tax information from independent contractors. A W-9 will allow you to collect the correct information from your contractor and document it correctly on your taxes.
NOTE: You’ll want to get this W-9 filled out BEFORE construction starts. Suppose something goes wrong with a project, and communication with a contractor becomes challenging. In that case, it’s almost impossible to get sensitive personal information of this kind after the fact.
- The Final Lien Waiver: This document indicates that both you and your contractor agree a project is completely based on the contract agreement, AND the contractor does not have any grounds to make a claim or file a lien against the property. Said another way, this document explicitly states that all work and services at the subject property have been completed and that the contractor has been paid in full for said work and services.
You should never send a final payment to a contractor until all work has been completed to your satisfaction. But once you have done your final walkthrough and have signed off on every deliverable indicated in the scope of work, it’s time to have the contractor sign the lien waiver and then cut your contractor a check.
NOTE: Never pay the contractor their final payment until they have signed the final and unconditional lien waiver. That way, you can rest assured they won’t place any liens on your property after your rehab is complete.