Short Sale and Phantom Tax Debt Relief Overview
Lots of questions have arisen from people since President Bush signed into law the Mortgage Forgiveness Debt Relief Act of 2007, whereby in certain circumstances, a homeowner does not have to pay federal income tax on debt forgiven on a loan secured by a qualified principal residence via a short sale, foreclosure, deed in lieu, loan workout or short refinance where the loan amount was reduced and forgiven in order for the homeowner to keep the property.
It is somewhat confusing just reading a bill with only references to other sections of the law. Below is the text of Section 2 of H.R. 3648 that specifically pertains to mortgage forgiveness. To save you the hassle of cross-referencing all this, I have included the sections of the IRS Tax Code that were added to or modified as a result of Section 2 of H.R. 3648.
SECTION 1. SHORT TITLE.
This Act may be cited as the ‘‘Mortgage Forgiveness Debt Relief Act of 2007’’.SECTION 2. DISCHARGES OF INDEBTEDNESS ON PRINCIPAL RESIDENCE EXCLUDED FROM GROSS INCOME.
(a) IN GENERAL. Paragraph (1) of section 108(a) of the Internal Revenue Code of 1986 is amended by striking ‘‘or’’ at the end of subparagraph (C), by striking the period at the end of subparagraph (D) and inserting ‘‘, or’’, and by inserting after subparagraph (D) the following new subparagraph: ‘‘(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010.’’.
(b) SPECIAL RULES RELATING TO QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS. Section 108 of such Code is amended by adding at the end the following new subsection:
‘‘(h) SPECIAL RULES RELATING TO QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS.—
‘‘(1) BASIS REDUCTION.—The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer.
‘‘(2) QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS.—For purposes of this section, the term ‘qualified principal residence indebtedness’ means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting ‘$2,000,000 ($1,000,000’ for ‘$1,000,000 ($500,000’ in clause (ii) thereof) with respect to the principal residence of the taxpayer.
‘‘(3) EXCEPTION FOR CERTAIN DISCHARGES NOT RELATED TO TAXPAYER’S FINANCIAL CONDITION.—Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.
‘‘(4) ORDERING RULE.—If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount H. R. 3648—2 of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness.
‘‘(5) PRINCIPAL RESIDENCE.—For purposes of this subsection, the term ‘principal residence’ has the same meaning as when used in section 121.’’.
(c) COORDINATION.
(1) Subparagraph (A) of section 108(a)(2) of such Code is amended by striking ‘‘and (D)’’ and inserting ‘‘(D), and (E)’’.
(2) Paragraph (2) of section 108(a) of such Code is amended by adding at the end the following new subparagraph: ‘‘(C) PRINCIPAL RESIDENCE EXCLUSION TAKES PRECEDENCE OVER INSOLVENCY EXCLUSION UNLESS ELECTED OTHERWISE. Paragraph (1)(B) shall not apply to a discharge to which paragraph (1)(E) applies unless the taxpayer elects to apply paragraph (1)(B) in lieu of paragraph (1)(E).’’.
(d) EFFECTIVE DATE. The amendments made by this section shall apply to discharges of indebtedness on or after January 1, 2007.
The following are the sections of the IRS Tax Code that were added to or modified as a result of Section 2 of H.R. 3648. Anything that was to be deleted is still there, but with a strikethrough. Additions are highlighted in yellow.
Section 108. Income from discharge of indebtedness
(a) Exclusion from gross income
(1) In general
Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if -
(A) the discharge occurs in a title 11 case,
(B) the discharge occurs when the taxpayer is insolvent,
(C) the indebtedness discharged is qualified farm indebtedness,or
(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness., or,
(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010.(2) Coordination of exclusions
(A) Title 11 exclusion takes precedence
Subparagraphs (B), (C), and (D) of paragraph (1) shall not apply to a discharge which occurs in a title 11 case.
(B) Insolvency exclusion takes precedence over qualified farm exclusion and qualified real property business exclusion
Subparagraphs (C)and (D), (D) and (E) of paragraph (1) shall not apply to a discharge to the extent the taxpayer is insolvent.
Section 108. Income from discharge of indebtedness
(h) Special rules relating to qualified principal residence indebtedness
(1) Basis reduction
The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer.
(2) Qualified principal residence indebtedness
For purposes of this section, the term ‘qualified principal residence indebtedness’ means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting ‘$2,000,000 ($1,000,000’ for ‘$1,000,000 ($500,000’ in clause (ii) thereof) with respect to the principal residence of the taxpayer.
(3) Exception for certain discharges not related to taxpayer’s financial condition
Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.
(4) Ordering rule
If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount H. R. 3648—2 of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness.
(5) Principle residence
For purposes of this subsection, the term ‘principal residence’ has the same meaning as when used in section 121.
Two key terms require defining within the context of the Code.
- Principal residence is defined in this link to Section 121.
- Acquisition indebtedness is defined in Section 163 cited below.
Section 163(h)(3)(B)
(B) Acquisition indebtedness
(i) In general
The term ”acquisition indebtedness” means any indebtedness which -
(I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and
(II) is secured by such residence.
Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.
Comments
252 Responses to “Short Sale and Phantom Tax Debt Relief Overview”
Insight into these kinds of transactions is always helpful. Being knowledgeable and motivated are key to surviving in today’s more difficult market conditions. Don’t you agree that putting both of these halves together is the ingredients of success??
Tim,
It sounds like your comment is directed more to real estate agents. I’m not sure many read what I write, but I’ll agree that in this market, an agent without knowledge is worthless. The other side of the coin should not be motivation, but fiduciary - looking after the consumer’s best interest.
Agents are taught by trainers and coaches to go after distressed sellers for business. I wish you guys wouldn’t push it as the “low hanging fruit” - the easy way to get business.
Homeowners facing distressed situations need the most knowledgeable and most qualified assistance out there, not the agents who brands themselves as the “short sale expert”, and doesn’t know what they are doing, or worse, doesn’t care as long as they close the transaction.
After 18 years in this business, I can tell you that most in the real estate “coaching” business, who teach agents how to twist or manipulate the truth, are more of a disservice to the consumer than a benefit.
Thanks for the inspiration though Tim - I’ll follow up on this with a consumer Agent BS Meter - “Lies, Damned Lies and Real Estate Agents”.
I own 2 houses. I live in one and the other one is rented. Which one will apply better for a short sale? If I do it with the one I live in will the bank take money from the one I have rented if there is any equity?
Thanks for your guidance!
Lucy, you can do a short sale on either if the lender agrees, but the debt forgiveness would only apply to the primary residence, and only to “qualified acquisition debt”.
A lender can’t go after other assets on a short sale, but they can require you bring money to the table or to sign a note where you are still liable for the difference in the amount owed and what the bank nets as a condition to releasing the lien on the property and allowing it to be sold.
Some lenders will come after you for a deficiency judgment once the short sale is completed. It is important to have the lender’s short sale documents and terms reviewed by an attorney prior to signing.
Do not rely solely on the advice of your real estate agent or the lender.
I am thinking of a short sale of my home because of fincial hardship of being laid off last Oct., it is my primary residence and I have a 1st and 2nd mortage with the same lender. This new law that past does this keep me from getting a 1099 form for the difference? Even if I have a 1st and a 2nd mortage?
Mary,
You are forgiven the debt and you are not held liable for the taxes on the debt, i see no way that you could then 1099 it.
I am not an accountant but that is how i see it.
Great post!
-Steve
Steve is correct that there would be no tax liability as long as the forgiven debt qualifies as acquisition debt - “indebtedness which is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer”.
I had 2 jobs last year and lost both due to job reductions. Found a job but at a reduced wage. No way to keep the house and foreclosure process to begin feb,15th. Want to short sell and have debt forgiven but i keep reading the phrase ” forgiven in order for the homeowner to keep the property” and I know right now I cannot keep the property and survive. How do I know the debt will be forgiven?
Hello Bob,
I have a construction loan for a house I had planned to move into when completed. The propblem is the house was never even begun to be built.
The indebtedness is for the aquisition of the lot and construction of a home on it to live in.
I am now negotiating a short sale of the lot with the lender (a combination of a buyer I have located and additional cash provided by me) & the lender is telling me that he is required by federal law to issue a 1099 for the amount of the difference between the loan balance and the monies the lender is paid as a reslut of the short sale.
This is on the order of $125K. Even in the 15% tax bracket, that would equate to an $18,750. tax bill.
Am I to understand that I can exclude the amount on the 1099 the lender sends me from my income & thus get tax relief?
While I am able to assemble cash needed to complete the short sale, the extra $18K is a deal breaker that could lead to foreclosure and, the lender tells me, subsequent deficiency judgment to be persued by a collection agency “for as long as it takes”. What a nightmare!
What tax form do I use to exclude the 1099 amount from my income? This would be true tax releif if it is the case!
Tom
Kenneth,
“How do I know the debt will be forgiven?”, is an important question many don’t ask because they assume short sale and debt forgiveness are the same. It doesn’t hurt to ask this upfront. You’ll get one of three responses - ‘yes’, ‘no’, or ‘we’ll let you know’.
If the loan is non-recourse, where the lender can’t come after you for a deficiency judgment, they are more likely to forgive the debt in a short sale. In instances where the lender is likely to seek a deficiency, they probably won’t tell you until you are well into the escrow where you are less apt to back out. You’ll see it in the approval docs they send you.
The lender may require a note or could have language that says that they agree to release the lien on the property in order to sell it, but they are not releasing the underlying debt. It is important to add language into any purchase agreement that makes the deal contingent upon the seller ’s approval of all lien holder conditions.
Tom, many lenders have been telling homeowners that they will seek a deficiency. You need a tax attorney to advise you on options and how the IRS would treat this situation, and/or assist in the negotiations.
They are correct about the statutory requirement to file the 1099C, regardless of how the IRS will treat any debt forgiveness.
My questions are much like the others–I own my home of 11 yrs, got engaged WE bought another home, things went south, I moved out he moved out the house is now up for short sale. Can they file a lien against my home for the bal?
He also has a home, will they divide the amount between us? If they 1099 me can I get debt relief from the
amount of the 1099? any light you can shed on the answers would be greatly appreciated. I have to research online but not fairing very well!
Thanks,
Michelle
Hello Bob,
I had lost my job last year and now I am Short-selling my property and I owe about 715k split 80/20. The Property is approved to sell for 430k and the lenders have approved the short sale. Will I get hit for a 1099?
Michelle, unless you used the first property as collateral, then the lender cannot come after other property. If they can go after a deficiency,then they may choose to seek a deficiency judgment. If the lender forgives any debt, they are required by law to send you a 1099C. If they forgive the debt, then there is no deficiency.
Assuming they forgive the debt, any tax relief on the forgiven debt would depend on a) the property being your primary residence and b) if the debt forgiven was acquisition debt. If you are both on the note, then you would both have to deal with the potential tax issues.
You do need to speak with a tax attorney or cpa.
Wade,
If the lien is released and debt is forgiven, the lender has to send you a 1099C. Whether or not you qualify for the tax relief on the forgiven debt is not a determination the lender makes.
Bob,
I appreciate your clarifying this situation. It seems that some Realtors believe that anyone can do a short sale and not worry about the possible taxation because this bill was passed. That concerns me as a Realtor myself because our duty is to give our clients accurate information and also to refer them to their tax professionals for details. I basically tell my clients that there could be tax ramifications and that they should seek tax advice prior to committing to a short sale.
I have linked your blog in a comment I made on mine at http://activerain.com/blogsview/350958/What-are-the-tax
Thank you for taking the time to dig out the portions of the code that the bill referred to.
I had a short sale in 2005 and was assessed $13,000 is tax, plus interest and fees equaling over $18,000. I have paid most of this off, about $16,500. Can I contact the IRS and get some of this back?
I’m confused a bit on the Acquisition Debt part. I bought a house for $330k, refi-d a couple of times along the way, and the last time was to pay my ex $55k as part of the divorce settlement. I currently owe $580k, as I was paying neg. am. while the divorce took 2 years. Am I not able to get tax relief on anytthin other than the original $330k? Landscaping, flooring, etc.?
Bob, the new law only applies to transactions that close after Jan 1, 2007 to Dec 31, 2009.
Scott, refi debt that is used to substantially improve the property qualifies. I do not know how the IRS defines “substantially”.
I did a short sale due to divorce back in April 2002. There was a primary mortgage and a home equity loan. The short sale did not cover the home equity loan at all. To do the sale Chase had me a sign a document saying that I would pay it back. Because my exhusband filed bankruptcy, Chase would not let me pay. They, then, wrote the loan off but I had to then pay a collection agency. Eight months after the collection agency lost it’s license, April, 2007, Chase contacted me and told me I had to agree to a settlement. When I did, as I had no choice, they told me they were going to submit a 1099 for the difference. And the amount they are going to use is even higher than the loan amount started out at. They won’t even show me a statement of how they came up with this amount and are not taking into consideration all the payments that I made. Will this law solve my problem since the settlement was in 2007?
Carrie, your question raises some interesting issues -
- does the law apply to when the sale occurred, or when the debt was forgiven?
- how does the bankruptcy come into play?
- is the lender making a mistake by not providing you with a statement?
This is certainly worth the expense of an hour consultation with a tax attorney experienced in this aspect of the tax code. I would bet there is more than one argument that could be made on your behalf.
Our fixed mortgage just went adjustable and jumped $500/mo. We came upon a company that says that they are able to get a loan modification that will include principle reduction. Thay claim that we will not have to pay any taxes on the debt forgiven and it will not affect our credit. Is this possible? We of course pay them a lump sum before they do this for us. Are we being scammed? Thanks for your insight.
Andrea - if the lender is willing to do it, you don’t need to pay a third party an upfront fee, although some attorneys will take a retainer to do this.
They can’t guarantee no credit hit in every situation, and if there is debt forgiveness on debt that doesn’t qualify under the new law, they can’t promise you that there won’t be tax issues.
If you email me the name of the company. I’ll have someone check it out for you. Email is bobwilson@gmail.com.
I just bought my condo last Feb 2007 and found myself out of a job at the end of the year. I’ve placed my property up for a short sale. The lender has assessed it for $13000 below what I owe for the mortgage balance. If it sells for less than the assessment price, will I have to make up that difference or will it be written off?
We paid 695K for our house, it is now appraising around 425. With the new Mortgage Forgiveness Debt Relief Act of 2007, how do we keep our house and have our loan re-structured to the current value? We have not missed any tax, insurance, or mortgage payments. Any advice would be greatly appreciated.
Thanks
I spoke with my lender and they kept omitting the second loan in our conversations. I will have to reapply for modification because I won’t have the loan for a year until today (1/29) so the application I submitted at the end of October was denied.
During one of the times I called back last week, I was told there was no “one-year” waiting period. They’ve decided this toward the end of December 2007, which was just two weeks after they denied my application.
When I finally got transferred to the person assigned to my case, she told me that I needed to resubmit and at the least show that I have more income to have anything done. I would have to be very optimistic of how much I’m making because I am a real estate agent / loan consultant with a regular full-time job to try to save my family from being out of a house.
I’ve considered deed in lieu of foreclosure — not a good idea — huge credit ding.
I’m currently considering short sale, but I am pretty certain that the HELOAN will not be forgiven unless I have that in an agreement before proceeding with the short sale.
For the loan modification, I have to show I have money to pay.
For the short sale, I have to show that I am insolvent.
I had initially asked for deferment, but I would have to miss a few payments for that to happen and I don’t want to risk having a 90-day late on my credit report. It seems a lot of people are put into this category because they are not aware of other alternatives.
I’m sort of lost now because it seems that I have no alternative but to make more money to get out of this sticky situation. Anything that I missed?
You pretty much covered it, except which state you are in. If it’s a non-recourse state like California, that puts the deed in lieu back on the table as an option where you weigh credit against a deficiency.
I would pursue the negotiation with the lender on releasing the debt if you can do the short sale.
Bob,
My story is pretty much the same as everyone else. We purchased our home February 2007. My husband was laid off in December, we can’t afford the mortgage anymore and since the home hasn’t gained any equity our shots at selling it to break even is not likely so we are facing a short sell or foreclosure. I’m trying to understand the real estate lingo here and am trying to understand if we do a short sale and have debt forgiven does this qualify as acquisition debt as described in your definition (“indebtedness which is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer”). It is our primary residence. Your reply is very much appreciated.
Rachel, unless you refinanced since you purchased the property, it would be acquisition debt.
Just trying to understand all of this. When exactly is the debt forgiven? Is it only if someone files BK? If the bank agrees on a short sale? Or if someone walks away from their house and lets it go into foreclosure, it goes back to the bank and the bank EVENTUALLY sells it at a loss, does the person still have to pay the bank for the difference of what the loan balance was and what they actually sold it for? If so, what is the meaning of the tax relief? If one is still paying the balance, why would there be tax due on it? I thought I understood how it worked until today when I was told by someone the homeowner still had to pay the difference.
Lots of great information above. Thank you.
I have a few questions, and my apologies if these are a duplicate of a question above.
- Scenario - Second home (Cabin), mortgages (80/20) on property are from Original Purchase in 05′. I would not qualify for relief because it is not my primary res, and because it was in 05′ correct?
- There are many investors out there right now making offers on properties in Short Sale. Does it make a difference to the Seller who purchases the property. Investor vs. Owner Occupied purchase?
Thanks!
Nate
Cindy’s comment is interesting, Bob what about walking away when the bank keeps lying and changing their story every time you talk to them. My real estate attorney says walk away, you’ve try to negotiate a short sale with your realtor’s help. I know this will have negative effect on credit but with if you have to transfer and there’s no other way!
My situation is like most peoples. I bought a house in Dec 2006 for my primary residence for $675K. I got an 80/20 on the loan both with the same lender. I am now out of work and cannot afford the payments any longer. We are going to move back to our other house we own that is now being rented out. We have to do a short sale on the house being that it is now only worth $500K. My question is will I be able to fit in the new tax relief or will I have to pay taxes on the remaining balance. Also I have not had any mortgage lates yet, I am very concerned about my credit. Will the short sale be reported on my credit. Thanks for your help.
We just short saled our townhouse this morning. It was not our primary residence. We owned it since 01′ and had it on the market for almost 5 years. We did refi in 04′ to take out equity because my husband lost his job. Our ARM was up in 06′. The interest rate ended up going from 6.5 to 12.95!Since we owned the property, we put about 40-50k in renovations. I guess I am asking if we fall under the debt relief act? Is it all short sales or are there stipulations? In the acceptance letter from the lender, I made sure it stated zero deficiency. The difference from what we owed and what they accepted was around 62k.
What’s really irritating is Bush’s comments on the passing of this Act:
[quote] The President welcomed those in attendance, saying, “Thank you all for coming. Welcome to the White House. I’m pleased to sign a bill that will help homeowners who are struggling with rising mortgage payments. The Mortgage Forgiveness Debt Relief Act of 2007 will protect families from higher taxes when they refinance their homes. It will help hardworking Americans take steps to avoid foreclosure during a period of uncertainty in the housing market.” [end quote]
How does this Act help people who have not lost their homes through a short sale?
What has the Mortgage Forgiveness Debt Relief Act got to do with REFINANCING?!
Aimee, how much longer will you be able to live in your home before you must move out?
Bob, I just read this comment by you on another blog post:
[quote] Keep in mind that this law wasn’t designed to create more short sales, but to allow flexibility for loan workouts so homeowners can stay in the property. For example, if you bought the property for $800k and now it is worth $600k, the bank’s net will be somewhere in the mid $500s with a short sale at market value. If you can handle the payments on a loan that is more than the lender’s net, it is in everyone’s best interest to simply redo your loan. This wasn’t an option many looked at before because to reduce the loan created the taxable phantom income and subsequent tax. [end quote]
Are you saying, then, that this Act applies to refinances, too, where the homeowner continues to live in the home? Wha….?! How is that possible? You mean the lender may agree to reduce the principal balance? Based on what? Must the homeowner fall completely behind on payments before a loan modification is considered?
Yes, it applies to loan workouts where the borrower wants to stay in the home and the lender reduces the loan amount, thus forgiving some debt.
One scenario would when you have a 1st and 2nd on a primary residence with the same lender. A short sale would wipe out all of the 2nd and part of the 1st. The lender forgives the 2nd entirely and restructures the 1st. The homeowner keeps the house and the lender avoids a foreclosure or short sale that lowers the surrounding comps even more.
Bob,
We purchased our home in 2005 for $556K, and have a 80/20 Loan with two diffrent lenders. Due to financial situation we are unable to keep the home. It is currently worth $399K, we have not refinace or have any lines of credit since the purchase of the home. We are wanting to sale our home so we are facing a short sell or foreclosure. If we proced with a short sale would be hit with 1099? We were also told if the Feds did not taxe you, you could be Taxed by the State? Do we qualify for debt forgivens?
Lucy
Well, that is truly incredible. This news will be a blow to all the so called Short Sale Consultants out there who are licking their chops that foreclosures are up 79%.
Have you heard of any lenders reducing the principal balance, thus allowing the homeowner to remain in the home? So far, only short SALES are occurring.
What you’re suggesting makes perfect sense because, as it is, it’s like the housing version of musical chairs out there.
I see one downside: people could merely stop making their payments as a negotiating tool to force the lender to forgives the 2nd. It wouldn’t be right for the lender to be forced into taking it in the shorts just because this Act provides relief to the homeowner.
Cindi - excellent questions.
Question: When exactly is the debt forgiven?
Debt can be forgiven by the lender if they choose to reduce the debt owed in a loan workout, in certain short sale situations, or in certain foreclosure situations.
Question: Is it only if someone files BK?
No.
Question: If the bank agrees on a short sale?
Debt is forgiven in a short sale when the lender agrees to release the lien and allow the property to be sold AND agrees to not come after the borrower for the difference between the loan balance and the payoff.
Question: Or if someone walks away from their house and lets it go into foreclosure, it goes back to the bank and the bank EVENTUALLY sells it at a loss, does the person still have to pay the bank for the difference of what the loan balance was and what they actually sold it for?
Yes, in circumstances where the lender has recourse (the ability to seek a judgment against you for the difference between what was owed and what the bank eventually sells it for). California is a non-recourse state, so adeed in lieu or foreclosure that results in a trustee sale usually means that the lender gets the deed in full satisfaction of the debt.
If so, what is the meaning of the tax relief?
The IRS considers forgiveness of debt to be income. You owe $50k, but don’t have to pay it back, the IRS sees that as you making $50k, so they tax it as income. The tax relief this bill provides means that you don’t have to pay the tax on the forgiven debt.
If one is still paying the balance, why would there be tax due on it?
In that situation, there would not be any tax relief since there is no forgiven debt to tax.
Sometimes the homeowner is asked to take a note for the difference. Sometimes the lender decides to sue and seek a deficiency judgment, providing the terms of the loan allow them to do so.
Nate, the cabin wouldn’t qualify if it isn’t a primary residence. The ‘05 purchase date does not matter. What matters is the year the debt forgiveness occurs.
The bank won’t care if the buyer is an investor or one who intends who to use it as a primary residence.
The question I can’t answer here is whether or not a second home can qualify as a primary residence.
Joe, has your attorney spoken with the bank?
Jennifer, have you approached the lender about a loan modification? It is possible that they could forgive the second if you continue to pay the first. It would be up to them if they reported anything to the credit bureaus. If they did, it would be as a charge off.
Aimee, the debt forgiven on an investment property would not be eligible for tax relief. You should check with a tax attorney or CPA to see if bankruptcy or filing insolvency with the IRS may be an option.
Lucy, lenders are required by law to file a 1099C if they forgive debt. Nothing I have seen changes that requirement.
I don’t know how each state treats this type of situation, but it would not surprise me if many still tax this as income. The IRS would not tax the debt forgiveness on the acquisition debt for a primary residence.
Catherine, yes I know of some who wanted to stay in their homes and have negotiated loan modifications.
We did a short sale on our primary residence in April 2007. We agreed to a promissory note for $58000.00 over 20 years and now we rec’d a 1099-C for $35000.00. With this new law, are we required to claim the cancelled debt as income or not? Please advise…….Thanks
Bob, so if I understand you correctly, the debt forgiveness relief act means absolutely nothing to California homeowners except those people who want to stay in their house and the lender works out a deal and reduces the amount of the debt? In all other scenarios, the balance is forgiven or written-off and because we live in a non-recourse state, the bank come after the homeowner for the difference? So the only bad thing for people who want to or have no other choice other than to just walking away from their houses is a mark on their credit? No other consequences?
Thank you!
The part of my question should have read:
In all other scenarios, the balance is forgiven or written-off and because we live in a non-recourse state, the bank CAN’T come after the homeowner for the difference?
(Sorry for the typo)
Bob, I just reread your response to me. This could also be the opposite in that this relief means alot to every Californian who loses their house for whatever reason because it is ALWAYS written off unless someone is not educated on California loan laws enough to know that they don’t have to pay back the difference and they voluntarily agree to take on a note with the bank agreeing to pay back the difference without knowing that the bank cannot come after them. ?? Sorry, I am still confused. I guess I am just trying to understand what is deterring people who are struggling to stay in their house that’s value has declined to not just walk away? My assumption is most people who bought in the last 2-3 years, put zero down on their purchase so they don’t have much to lose except a bad mark on their credit. Am I wrong?
Bob,
Our principal residence was foreclosed Oct. 2007. Our first mortgage lender ended up purchasing the property covering only their balance and property taxes. Our second mortgage lender is still sending us monthly bills. I already spoke with them and told them that the property is already foreclosed and therefore will not pay them anymore. They said that they will continue to do this until they decide that it is uncollectible and then will 1099 us. We are about to file our taxes. Does this mean we don’t have to report the foreclosure until next year since we don’t have the 1099 from the lender yet?
Kevin, that is a question for a tax expert.
Cindi, it is not always written off. Purchase money loans are non-recourse in California, but Helocs and refi loans are not always non-recourse. A huge number of homeowners have refinanced out of their original non-recourse loans into recourse loans. On these loans, the borrow would need to check the terms of the loan to determine whether or not the lender has recourse or not.
CS, I don’t know how the foreclosed first affects the 2nd in your situation. You need to talk to a tax expert who understands the foreclosure laws in your state.
Bob wrote: “One scenario would when you have a 1st and 2nd on a primary residence with the same lender. A short sale would wipe out all of the 2nd and part of the 1st. The lender forgives the 2nd entirely and restructures the 1st. The homeowner keeps the house and the lender avoids a foreclosure or short sale that lowers the surrounding comps even more.”
Is this really happening?? We are looking to modify our two loans (re-fi both w/Citimortgage). We are afraid to pursue a short sale since our loan is conisdered recourse and Citi coud come after us for the 97K on the second. Are lenders really forgiving part of loans under a loan modification/workout??
Question….my husband and I divorced 15 mos. ago. We owned a home together. In June of ‘07 our mortgage company agreed to a short sale at fair market value, which was 79k less than we owed on the mortgage.
We have EACH received a separate 1099 with the amount of 79K on each one. Is this so that at least one of us presents it during tax prep, or do they expect BOTH of us to claim it? If so, it seems to be doubling the amount ? Thanks for your help.
I am considering a short sale on my home in michigan. Is it better to strike a deal wtih a bank to pay off part of the deficiency so that they will not sue me? Also, what are the tax implications of a short sale vs foreclosure? Under the new mortgage law, will I have to pay taxes on the deficient amount in April 08?
Cynthia, speaking with the lender first is important. Every situation is different, so until you talk to the lender you don’t know what options are available to you. Unless there is equity, no lender wants a property back.
Cathy, yours is tax question and I don’t know the answer.
Barb, it is important to start off by asking the lender what options they would consider.
You need to talk to a qualified tax expert about the tax consequences. The debt forgiveness law applies to debt forgiven, not deficiencies.
I bought a house with the intention of moving into but chose to keep my primary residence. I never told the bank that I was now going to use this property as an investment property. Now I cannot carry this mortgage even with renters. My question is now that I am going through a short sale, can the bank come after my personal assets like my roth IRA for the difference in the short sale settlement. What would be my tax liability?
My business is suffering. We have been trying to manage our $5000 mortgage payment on our $3600 a month. The drop we initially assumed was the fires….it still is not picking back up. Currently we are due. Our first mortgage will not negotiate the terms. We have no late payments on our credit to date. We live in Southern CA and our mortgage is about 65k over the value of our home so selling is not an option. I have talked to attys and realtors and everything we hear is so contradicting. Is there somewhere specific in our loan docs we can locate what their recourse would be?
Jen, CA is a non-recourse state. You should stop making the payments and live in your house until you can no longer live in it. If you make your payments on everything else, you’ll be surprised how quickly you can recover from this unfortunate event. Save your housing expense money to regroup. Tomorrow will be a brighter day. You’ll see.
Kevin - Not in most cases.
Catherine - while California is a non-recourse state, that does not mean every loan is non-recourse, so your advice to Jen may not be correct.
Jen, give me a call. 858-382-5820.
Bob, I am thinking of a short sale and am wondering if I have to be behind in payments to do a short sale. I put quite a bit of money into the house to bring up the value. My timing was bad and in spite of the very considerable home improvements, the value has decreased below the amount now owed. The area tanked. My payments are due to go up to 13.5% and I can barely afford what I am paying now. I don’t know what to do or where to start. Can you give me some advice?
Billie, did you know that conforming loan limits are legislatively due to increase to $729,750 in high cost areas? Your post doesn’t say what state you’re in, but that may help you. If you’re already in a conforming loan, the new higher loan limits probably won’t help.
But, frankly, Billie, there’s no benefit to a short sale relative to qualifying for an institutional loan a minimum of two years down the road and/or your credit score. You may as well live in the house until it goes to Trustee’s Sale and use the time to regroup by banking your housing expense for the months that it takes for the lender to foreclose.
I forgot to mention, Billie, that by living in your house rent-free for as long as it takes for the lender to foreclose, you would be effectively recouping some of your fix-up money, would you not? Perhaps if you think of it that way, your anguish will be lessened.
I would caution you, however, not to try to stay in the house so long that the lender is forced to file an unlawful detainer action. UD is the kiss o’ death where prospective landlords are concerned. Many landlords will show mercy to a consumer who has suffered a foreclosure, but not one who has forced a lender (or landlord) to forcibly evict.
Bob, With HR 3648 Do I still need to show the 1099 form we received when we do out taxes?
what is the difference between 1099B & 1099C?
I received a 1099-A, not a 1099-C……what is the difference? Also, I already filed my taxes before I even knew of this debt relief act. Will I have to amend my return?
Maggie and Joyce,
This IRS publication explains the different forms:
http://www.irs.gov/efile/article/0,,id=98114,00.html
Here are the IRS instructions for forms 1099-A and 1099-C:
http://www.irs.gov/pub/irs-pdf/i1099ac.pdf
We bought a townhouse for $352500 with 80/20 under my wife’s credit and name. This is our only and primary residence and I have not been late in any payment until today. However I am the one that makes the payments since my wife is home with our baby. Because of my financial situation, I am strugling and cannot pay anymore. In our situationm, can we benefit from “The Mortgage Forgiveness Debt Relief Act of 2007″? If we consider shortsale, will we end up owing taxes on the forgiven debt? Does this “Debt relief Act” help us to seek a loan modification not only on lower interest rates but lower the initial debt of $352000 to a current market value of the property?
Some realtors have advice me not to pay anymore and stay in the property until the lender decides to shortsale, so we can take advantage of free home until it sells. After leaving home, will we still be able to rent an appartment or townhouse, after getting my wife’s credit hit for the shortsale? I will appreciate any advice or comment.
Hi Daniel.
A few questions.
Do you have the same lender for both loans?
What state are you in?
Thank you Bob,
No, we do not have the same lender for both loans.
We are in Virginia.
This is more informative than the dozen or so attorneys I’ve spoken to. For whatever reason, nobody will give me straight answers - they don’t seem to want even to take my money!
My situation is unusual. We have 2 mortgages on the house. The 1st is for the acquisition value. The 2nd is extra and thus doesn’t qualify as acquisition debt.
Both debts are in my name alone - though the trust deed and the title are in both of our names.
My questions are:
1) If we do a foreclosure, will my husband’s credit be affected?
2) In a foreclosure, since we are in CA - there is no deficiency right? They won’t be able to come after anything post-foreclosure.
3) If I apply for a short sale, will the bank be looking at my husband’s income? Mine is small and I was hoping that it would be sufficient to get them to agree.
4) In the case of a short sale, will my husband’s credit be affected? (The loans do not appear on his credit report; the notes are in my name alone)
5) Do you know *any* real estate attorneys who might be willing to talk to me for a fee?
Thanks so much for your help!
Cheers,
Kate
Kate,
Is there one lender for both loans or two?
Kate, I’m a mortgage broker, so I feel qualified to answer your questions relative to credit.
1. Since he’s not on the mortgage note, no.
2. Not on the 1st (acquisition) but possibly on the 2nd (HELOC)
3. For the bank to agree to a short sale, you must prove hardship so, yes, they will ask about “household” income.
4. Since he’s not on the mortgage note, no.
5. I don’t know any in San Diego.
If you go the short sale path–(although I don’t know why you would, since a short sale trashes your credit the same as a foreclosure)–the lender may demand a promissory note and/or pursue you for the deficiency. If they attempt that, you may as well go to foreclosure.
Short sales are not always treated the same as foreclosures when it comes to credit reporting. It depends on if and how its reported. Credit reporting is not required. It can and is frequently negotiated with the lender.
Making a blanket statement about short sales vs foreclosures is irresponsible. Every situation is different. It is one reason why doing a short sale without an attorney at the ready is foolhardy.
Kate, you could be getting different answers for a multitude of reasons. Reading the law is not the same as first hand experience.
I have dealt with 5 different attorneys today. All of them see things a little different. One explained to me that forcing a TILA (truth in lending act) issue didn’t work with one lender because they are federally regulated. Another told me the way around that was to frame the argument differently. He turned it into a contract law issue. Case still ends up in Fed court. Lawyer A says no can do, Lawyer B takes a different tack and gets it done.
I have two attorneys in California you should contact. I’ll email their contact info to you.
Bob,
I’m in Florida and came across your site. A few questions regarding an second home (rented out) we purchased in South Florida. Won’t bore you with specifics, but the jist is we lose 1500 per month on the place, it is worth 60K less than what we paid and hurricane insurance just put our monthly association fees to 500 per month on the unit.
I have spoken to an attorney and he said stop making payments because a lender doesnt usually talk to you regarding a SS if you are current. We have paid faithfully for over 2 years.
1)Have you had any experience with Countrywide’s Home Retention Dept? They are hurting pretty bad as a company now and I was wondering if they are being stiff or flexible regarding SS or loan mods.
2)Are lenders negotiating loan amounts to keep you in a loan? I could afford the loan if it were at the current market value and would be willing to keep it since I have a tenant in place, but can’t afford it and the association dues at the current rate any longer.
3) I have fallen behind in association fees to the tune of 3K. I know a lien can be placed on the unit by the homeowners association, how does that affect a short sale?
4) Last and 2 BIGGEST questions…we have one other rental property that we break even on each month but have about 20K in equity in…A) have you ever heard of gifting that to a child or moving into a land trust to protect it from a deficiency judgement? B) Can a deficiency judgement call for garnishing of wages?
Matt,
I work with an attorney in California that also practices law in Florida. I’ll put you in touch with him.
To answer the questions I can:
1) yes. I am working with them now. They have an analysis they put the short sale offer through. If it makes sense, they try to do the deal. In some cases the deal make sense, but the loss can be so great that it takes a secondary approval if there is an investor involved. By that I mean if CW is servicing the loan for an investor.
2) I am working on that issue as well. That is more complicated. You need to call Customer Service and ask for a loan modification package.
3) In a short sale, liens get added to the good faith estimate and are figured into the payoff amount.
4) One of the biggest mistakes people make is transferring property incorrectly. Both ‘a” and “b” require an attorney to answer.
I’ll follow up with you via email.
What about foreign nationals. I have a client that owns four investment properties here in the US. All four are currently behind anywhere from 30 to 120 days. I have listed two of them as short sales for her at this point. We have a cash offer on one (she owes $300K, the offer is $275K) and the other should sell in the next month or two. The question is whether any ’shortage’ can really be recouped from her as she is a foreign national. I have, of course, advised her to speak with her attorney and tax professional regarding both liabilty and tax implications. However, I have yet to hear any definative answer from either regarding the general question of the true ‘reach’ of the lenders involved as it relates to foreign nationals. Please let me know your insight in this regard…
That would be an area where FIRPTA could apply.
In my experience of nearly 20 years as a loan originator, I’ve never ever–no, not once–seen a short sale reported on a credit report as anything but Score Factor Code #22–”serious delinquency, derogatory public record or collection.” Therefore, it was not irresponsible but factual to respond that a short sale and a foreclosure are treated exactly the same at the bureau level.
If, however, a short sale negotiator can persuade the shorting lender to report the short sale using a code other than Score Factor Code #22, that’s a significant coup for the negotiator and a slam dunk benefit for the homeowner.
If you would like to verify this fact, you can write to cbhelp@fairisaac.com and a Fair Isaac & Co. representative will call you back to discuss.
In addition, short sale and foreclosure are treated exactly the same by subsequent institutional lenders for loan qualifying purposes. A seasoning period of no less than 24 months stands between the former homeowner who went short sale or who was foreclosed upon and a new institutional loan.
If you would like to verify this fact, you can call any institutional lender and ask, “Is there any difference between a short sale and a foreclosure with respect to seasoning?” They will say, “no.”
There’s a lot of misinformation flying around the internet with respect to how short sales are treated by credit bureaus and lenders. I suspect it has a lot to do with the potential business that could be lost by realtors and short sale consultants when/if the consumer realizes there’s no benefit to a short sale as opposed to a straight foreclosure.
The practical reality is that the difference between short sale and foreclosure is the difference between being hit by a train or a bus. Your credit is just as trashed by a short sale and future lenders are just as cautious about lending to you again.
Could you be more specific? Do you have an opion on this based on your knowledge?
I am interested in the short sale idea. I have an investor willing to negotiate the short sale for me but is getting something out of it for him. I am concerned if I will be 1099ed the difference or “forgiveness”. The investor is thinking to sell the home on the short sale forgiveness negotiated and let me live in it and down the road buy it back. What will the future hold for me as far as the forgiveness in an attempt for me to keep the home. I may sell it, rent it and buy it again if do-able - what are your thoughts?
Mike, here is the IRS publication that explains FIRPTA, the Foreign Investment In Real Estate Tax Act.
Bev, what you are describing is the script for a very common scam. You should speak with an attorney.
Bev
This sounds like one of the classic scams. I bet he/she is suggesting that you first deed the property over in order to ‘facilitate’ his right/ability to negotiate, right? Step one is to consult an attorney. If after consulting an attorney to explore all of your available options (re-negotiated loan terms/payments, bankruptcy, short sale, foreclosure, etc.), if short selling is the one you choose, the last thing I would do is go to an investor/buyer and say, ‘please negotiate for me.’ They clearly will not be acting in your best interest.
Thanks Bob.
LOL, you beat me to the punch on Bev’s comment.
Catherine, thanks for the link, but my brother-in-law works for FairIssac.
One item you are over-looking is that not all short sales are reported as short sales.
From SFGate.com:
Nothing is boiler plate these days. Attorneys that were swearing off short sales 9 months ago are now using them in conjunction with TILA and RESPA laws to leverage lenders to negotiate differently.
With so many loans packaged as CMO’s, more and more banks are having a difficult time responding to specific RESPA related requests put forth by attorneys. As a result, we have seen loan servicers suddenly become very agreeable to the idea of not seeking a deficiency and follow through with a short sale. The credit reporting is negotiated as well.
Put credit aside for a moment though. For many, the bigger issue is not the credit, which frequently is already in the 500s, but the 5 or 6 figure deficiency they’ll never be able to pay off. At some point then, lenders just write it off. If this is done after the Mortgage Debt Forgiveness Act sunsets, you now have a tax liability.
Telling people to not bother with a short sale and just live rent free for a few months is bad advice if they face a deficiency as a result. Once they property is foreclosed, is there anything left to leverage in a negotiation about a deficiency? Not much that I can see.
I am the first to say that a short sale option is not always the best option, but if it provides negotiating leverage, then it is quite valuable. As far as the motivation providing bad advice, for some it is just ignorance. Regardless, that comment of yours was an ad hominem argument that argues the players and not the facts.
This distressed market is not like what you and I have seen in the past. The entire lending landscape is different. When mortgages became securitized, it changed the game. Foreclosures are now being challenged on the basis that the lender can’t readily prove they own the loan. This creates leverage in the hands of a skillful attorney.
I will continue to argue that one size fits all advice like “there’s no benefit to a short sale as opposed to a straight foreclosure” is extremely irresponsible.
Unless and until the homeowner brings the loan current through (1) payment of past due payments, (2) loan modification, or (3) forbearance, the practical reality is that s/he will lose the home through (1) straight foreclosure, (2) short sale or (3) deed-in-lieu. The short sale investor/buyer, because he hopes to resell for a profit, will negotiate on his own behalf. The lower the negotiated short sale price, the more profit he makes when he re-sells.
Once the homeowner is destined to lose the home, there really isn’t any “best interest” to be protected beyond trying to persuade the short selling lender to report the now derogatory mortgage trade line as “paid as agreed” (fat chance!) and not go after the homeowner for deficiency.
However, an ethical short sale investor/buyer will attempt to do just that: negotiate with the lender to (1) waive the deficiency and/or (2) not report the trade line in quite so devastating a manner as Score Factor Code #22. If the lender balks at either of these two benefits, the short sale consultant will not press the matter, because to do so would jeopardize his ability to buy the property at a discount and re-sell it for a profit.
Clearly, then, the short sale investor/buyer has a conflict of interest, whether he acknowledges it or not.
Mike, I don’t know if you were addressing me when you asked, “Can you be more specific?” but my answer is that my comments are based on my experience in dealing with FICO scoring issues and originating loans under the guidelines of Fannie Mae and Freddie Mac.
Adding to Catherine’s last comment, is that because the investor/buyer needs the lowest price, they are not usually the seller’s best option. One concern with being overly reliant on a low ball investor instead of getting a closer to market price buyer, is that if the investor deal is not approved by the lender, you may have run out of time.
If you do this on your own, make sure you have an attorney.
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Fair Isaac is in a quandary, aren’t they? If their scoring algorithm becomes even more transparent than it already is, and we all figure out how to “crack the code,” they’re out of business. So they will continue to obfuscate to protect their proprietary scoring algorithm, and no one can make them come clean with the exact details of how scores are derived. We do, however, know all about Score Factor Codes because they’ve been published all over the Internet.
As I said, I have never, not once, seen a lender characterize short sale, foreclosure or deed-in-lieu as anything but Score Factor Code #22. That doesn’t mean they can’t or haven’t used Score Factor Code #03 or its equivalent, which is much less damaging. Maybe they have. I’m stating what the lender is most likely to do, based on my analysis of thousands of credit reports over nearly two decades of originating loans.
What IS irresponsible is for anyone with skin in the game to tell a homeowner that a short sale will “save their credit,” or “you can recover faster from a short sale,” or any other wishful thinking. Since a short sale and foreclosure are treated the same (that dang Score Factor Code #22), and no future lender will lend until 24 months seasoning has passed (Fannie Mae underwriting guidelines), I see no benefit to short sale over foreclosure.
Perhaps someone has a thought about HOW short sale is better than foreclosure that I’m not privy to. If a short sale negotiator can negotiate a less damaging Score Factor Code, I’m all for giving that the old college try. An attorney using obscure fragments of the law to challenge the lender’s position is a unique twist.
Bob wrote: Telling people to not bother with a short sale and just live rent free for a few months is bad advice if they face a deficiency as a result.
I thought the “one action” rule says that once a lender has exercised its right to foreclose, no other action can be taken against the homeowner; therefore, the lender cannot come after the homeowner for a deficiency.
http://library.findlaw.com/1998/Aug/1/130432.html
Another “benefit” to the homeowner to foreclosure, not short sale, in my opinion.
In California when a debtor defaults on a real property secured debt, the creditor’s options are significantly limited by section 726(a) of the California Code of Civil Procedure. Commonly referred to as the one-action rule, section 726(a) most obviously aims to prevent a real property secured creditor from suing the defaulting debtor on the indebtedness itself prior to foreclosing on the security interest. If the debtor in the situation described does not raise the one-action rule as an affirmative defense and if the creditor obtains a personal judgment on the debt, the one-action rule would forever bar the creditor from foreclosing on the security interest.
Full text of Section 726(a) of the California Code of Civil Procedure can be found here…
http://law.onecle.com/california/civil-procedure/726.html
What you cite is part of the problem, created in part by lenders, agents and buyers who didn’t realize the potential consequences of 80/20 loans with two different lenders.
If the first forecloses, the 2nd doesn’t get his “one action” and can pursue a deficiency. It’s little things like that why blanket advice is dangerous.
I don’t want to take this overview of the Debt Forgiveness Act any further of course here. I’ll publish a post on foreclosure rules and we can continue this discussion there.
“Foreclosures are now being challenged on the basis that the lender can’t readily prove they own the loan. This creates leverage in the hands of a skillful attorney.”
Great Post. I am actually in Jax, FL where April Charney, the attorney going after the lenders is located. Interesting info regarding the repackaging of loans and proving who owns what or what portion of your actual loan.
Bob-the attorney you know who practices in CA and FL, do you know how successful or not he is in negotiating on an owner’s behalf? Also, in your experience, what is the overall cost from beginning to end of retaining an attorney to represent you in a situation like most people are facing. I sat next to 2 real estate attorneys recently on a flight, and they said I could do the negotiation myself with the lender…while I agree, I just feel a lender may take an experienced atty more seriously. Thoughts?
“Adding to Catherine’s last comment, is that because the investor/buyer needs the lowest price, they are not usually the seller’s best option. ”
In that case then, who should we as owners sell to and how do you not attract the vultures in the process?
Matt, Florida is tougher than California because there is not the non-recourse consumer protection. That leaves RESPA and TILA as the remaining leverage.
I believe the attorney adds value. If the lender stonewalls the seller, the options for the seller are to a)give in, b) fight on.
Option A means losing. Option B is stronger with an attorney fighting for you. I prefer to cut to the chase and have the attorney at the ready.
I have seen attorney fees from $1000-$2000 typical in quite a few cases.
Regarding the atty challenging the loans, April Charney…she is a member of NACA, who was started by Bob Marks…the atty guy who was ruthlessly pursuing lenders on the behalf of homeowners a few years ago. He once passed out fliers in a CEO’s neighborhood about the CEO of one company having an affair with a worker and pickets schools where the children of lenders’ CEOs attend, telling the kids their daddy’s are wicked. While aggressive, his company just teamed up with Countrywide, obviously, according to the pair, to help out homeowners. I say that with a sarcastic tone.
Bob-
To your best guestimate, from your experience and what you have seen…what percent of cases can an attorney negotiate a non pursuit of a deficiency judgement?
>who should we as owners sell to and how do you not attract the vultures in the process?
List the property. The investor/buyer who wants “to negotiate on your behalf” would likely preclude you from getting better offers.
While some may think listing the property is strictly a self-serving real estate agent task, if you do this in conjunction with an attorney and the agent knows up front that the end result is what is best for the homeowner, which may mean no sale, then you have your bases covered.
In Florida I am hearing of situations where the best end result is a deed in lieu with the lender agreeing to not seek a deficiency.
Matt, I don’t have a guess. I have seen attorneys suggest like Catherine that a deed in lieu or just walking away is the best answer, but lately i have seen more attorneys see that they can fight lenders and win.
One attorney I spoke with this week has had success in Federal Court and in some cases has had the mortgages cancelled outright.
Others are fighting on behalf of Spanish speaking borrowers who didn’t get loan docs and/or escrow instructions in Spanish.
“In Florida I am hearing of situations where the best end result is a deed in lieu with the lender agreeing to not seek a deficiency.”
Why would a lender want to do a deed in lieu when they already have a ton of real estate on their books that they must auction off. Wouldn’t that just be adding one more to the mix that they would have to auction off? Just curious.
Also if you did a deed in lieu of foreclosure and you have a tenant in place. Does the lender force the tenant to vacate or do they collect the future rent payments from the tenant?
I received a 1099-A for abandonment of my property. I’m not sure how they determined that, but, in any case, do I have to report as income the difference between the amount of the debt and the fair market value of the property? Or is this “forgiven” under the new tax rules?
Joyce - The gross foreclosure bid price is considered to be the FMV. If an abandonment (mailed the keys to the lender) or a voluntary conveyance to the lender (a deed in lieu of foreclosure) occurred, then they enter the appraised value of the property.
From the IRS:
Box 2. Shows the debt (principal only) owed to the lender on the loan when the interest in the property was acquired by the lender or on the date the lender first knew or had reason to know that the property was abandoned.
Box 4. Shows the fair market value of the property. If the amount in box 4 is less than the amount in box 2, and your debt is canceled, you may have cancellation of debt income. If the property was your main home, see Pub. 523, Selling Your Home, to figure any taxable gain or ordinary income.
Great blog ! We bought a house 2 years ago for $280k in CA. The current value is $255K. My work visa expired a couple of months ago and so I’m no longer able to pay for my mortgage. (also, I don’t think I can get it refinanced). I’ve used up all my savings to pay for my mortgage since then. Do you think short selling is the best option for me? Will I be covered by this new law? Thanks.
Bob,
Can you tell me if I understand this correctly. In CA, have recourse loan, refinanced at 90% LTV with PMI. I am moving this summer and am so far upside down decided to list home as short sale.
This law will not forgive my tax liablity for and forgiven debt b/c I refinanced. Is that correct?
Also, I have RESPA and TILA violation in my loan docs - can a good lawyer use this in negotiating a short sale - and how does the PMI come into play. If they pay a claim to lender does the lender 1099 me for that, or the PMI Co. - or does the PMI Co. have some other recourse.
This is all so confusing!!!!!!
Bob-
I have an option arm -1st and a heloc-2nd.(both are different lenders). Both loans were a cash out refi in California.
I just lost my job, not behind in payments, and upside down on the home.
1. Since the refi makes the loan recourse, does that mean I will pay taxes on the forgiven debt?
2. Does being insolvent eliminate taxes on recourse loans?
3. Is it possible to do a short refi if another bank has the 2nd?
4. Since I’m not delinquent, are banks more willing to ignore me?
Also, if you have any advice or recommendations it would be appreciated. I don’t want to walk away or stop paying my mortgage.
Thanks.
Tom, the law applies to the debt forgiven up to the amount of the original acquisition debt and any cash out debt used for “substantially improving” the property. I know lawyers are using TILA and RESPA issues as negotiating leverage. I don’t know the answer to the PMI issue.
Jason, if the debt is forgiven in a short sale, then recourse or non-recourse is not an issue. The confusion arises because many assume that a lender agreeing to a short sale is automatically forgiving the debt. That is not always the case.
A lender can agree to release the lien and therefore allow the sale to occur, but not release the borrower from the underlying debt. If the borrower signs off on a short sale with those lender dictated terms, then the borrower is still on the hook for the deficiency. This can happen with either a recourse or non recourse loan, but it shouldn’t if the loan is non-recourse.
Insolvency is one way to deal with the tax issue. It’s confusing and should be done with the advice of a tax attorney or CPA.
It’s possible to do a refi, but not probable. The answer to question #4 depends on the lender. Feel free to give me a call at 858-382-5820.
JB, with a non-recourse loan, you won’t have a deficiency and because it is a purchase money loan, no Fed tax. There may be a state tax hit though, unless California changes the current law to mirror the Fed law, which they are trying to do.
Your first call should be to the lender to see what options they can offer you.
Bob,
Thanks, that is a great load of my shoulders. A bankruptcy lawyer advised me differently. I only refinanced for a better rate and didn’t take any cash out. Once I learned about how I lost my ‘non-recourse’ status and then this issue it kind of felt like a double whammy. It’s funny how none of that is in the closing documents.
I am still confused on the PMI issue but I’m sure I’ll see how it mangages to play out I presume. This short sale business appears to be my only hope to avoid foreclosure, I’ve heard the odds of success aren’t too great but we’ll see how it goes.
If its recourse, the lender can still seek a deficiency. With a foreclosure, it’s up to the lender, but in California, it usually isn’t an issue because they normally opt to do a non-judicial foreclosure. If there are two lenders, one of the lenders may go after a deficiency because they didn’t get their one action (I’ll explain this later). With a short sale or deed in lieu, it comes down to the terms you negotiate, but a deed in lieu doesn’t work very often with two lenders because there is only one deed. One needs to agree to a settlement and to let the other take the deed.
Tom, what is avoided with a short sale is only the social stigma of foreclosure. In practically every other way, the two are the same.
In addition to my duties as a mortgage broker, where I see the results of foreclosure and short sale on FICO scores, I currently negotiate short sales for short sale investors. In nearly all cases, we get the deficiency judgment waived but, make no mistake, there’s little to no benefit to short sale over foreclosure unless you count avoiding the social stigma of foreclosure as a benefit (many people do). One can always say, “I wasn’t foreclosed, but I still lost my home.”
Catherine,
I don’t understand your reasoning. I am upside down but not behind on payments. I am well ahead of the ballgame on this; in foreclosure you are at least 90 days delinquent. I have an approval from my lender to negotiate a short sale and my loan is current and I hope to keep it that way. How is that the same as foreclosure? I realize neither is good, but the SS seems like the lesser of two evils for sure.
Just curious.
Tom, here are some facts to consider:
1. Most lenders require a hardship letter as part of the short sale package. They consider hardship to be when the borrower is behind in payments. How were you able to prove hardship? If you’re not behind and, most especially, if you have money in the bank, why should the lender approve a short sale?
If you were able to negotiate a short sale without being behind in payments, your case is an anomaly; an aberration.
2. Most lenders report a short sale to the credit bureaus as Score Factor Code #22–”serious delinquency, derogatory public record or collection.” They will also make a notation “settled for less than owed–short sale.”
This will prevent you from qualifying for another mortgage for at least 24 months. If you can negotiate that the lender will report your mortgage as “paid as agreed,” you’re home free. Absent that, ask them how they’re going to report to the bureaus. If they report your mortgage trade line as SCF #22, the impact on your FICO score is exactly the same as a foreclosure. Trust me on this one.
If all your other obligations have been paid on time, however, your “fall from grace” via SFC #22 will not be as devastating to your FICO score as someone who has let not only the mortgage but all his other obligations go to pot.
The only way you can be guaranteed to come out of this unscathed is if you bring your own money to the closing table. Many people do this. My sister “bought high/sold low” on two occasions and both times she brought her own money to close. Thus, her credit was preserved and she easily qualified for another loan.
If lenders routinely take properties back before the borrower is behind in payments and don’t report that fact to the bureaus, then all any homeowner would need to do is call the lender and say, “Hey, I’ve got to sell, and I’m upside down, but you’re OK with that, aren’t you? You’ll simply discount the note, right?”
It doesn’t work like that, unfortunately.
Bob is actively preventing the truth from being posted on this blog. I have posted many responses to explain how short sale and foreclosures impact FICO scores and what the lenders’ criteria for those who short sale/foreclose, but they are being removed.
Nice job, Bob.
Bob has also grayed out certain blog responder’s names so they can’t communicate with each other offline.
Nice going, Bob.
Bob obviously seeks to get as many short sale listings as he can through publishing this blog.
Where oh where can the upside down distressed homeowner obtain UNBIASED information?
Well, not here, that’s for sure.
Thank you Catherine.
Thank you for taking what was intended to be an unbiased overview of a topic and hijacking it to continue to hammer your views. I allowed you to do so. You brought good info to the conversation, but you have also made a few errors as well.
I have not been the advocate for short sales. I have simply presented information and options, and more than once made it clear that speaking with an attorney and tax professional is a must. The ONLY short sale listings I take have been either referred to me by their attorney, or I require them to speak with their attorney and/or CPA first.
You are telling sellers not to do a short sale, yet for your own investor clients, you do this. I assume so you can do the loan for your investor client. You also stated that you get the deficiency removed, however, there is little to no benefit to a short sale over a foreclosure. I would argue that getting the deficiency removed is a big benefit.
No. I wanted to respond, but my time was limited, so before you hijacked this any further, I moved your comments into a pre-moderated mode. However, I didn’t do it correctly, so you were then able to come back and post the last few comments before I could respond. I asked you to call me, but you didn’t. All of your comments have been published.
No. If someone leaves a link to their site, it is live. If they just leave a name, like you, then it is what it is. The email addresses of those who comment here are NEVER published and it would take a court order to get them.
As mentioned earlier, the short sale listings I have taken have all been referred by attorneys. I turn down most. It is only one option, and more often than not, not the best. When I do take a short sale listing, it is with the understanding that the client’s attorney dictates what is the best course of action for their client.
You have only one answer - walk. You cite laws you clearly do not understand. You have stated the one action rule, which can allow a recourse 2nd to seek a deficiency if the first forecloses and therefor the junior lien holder doesn’t get their one action.
Your advice is incomplete, and in some instances incorrect. Mine is to seek qualified legal and tax advice. Thank you for contributions.
I am in the military and have a security clearance that would be highly impacted by a foreclosure or bankruptcy. The JAG recommends short sale as the best option for the effects/affects that ‘this stigma’ will have upon my career. If it costs me some more money to negotiate that option I would be willing to consider it, dependent upon the amount and terms of course. I understand what you are saying though, it took three months of fighting with the mortgage servicer to get them to send me the short sale package, they have my hardship letter and I have a loss mitigator assigned. Nonetheless, I feel I do have some ammo to bring to the negotiating table with TILA and RESPA violations in the paperwork. They probably have some ammo of their own as well, and I understand it will be a negotiation and that they hold the cards.
Buying another home is not on my immediate horizon - so that’s not a concern, I’ve had so much luck with this one that I think I will put that off until I find someplace I will spend at least 10 years. Obviously, real estate wasn’t a real good investment as of late. If they don’t accept the short sale, then the property will go delinquent and eventually foreclose when I move. Therefore, my idea is to do something rather than nothing, I think it will bring more money maintained than it will spending months as a REO. Bringing six figures to the closing table is not something I can reasonably do. I have not one late payment on my credit report at all, but if I move that will change. Just the house. Huge mistake I made here and one I’m sure I will pay for in some fashion but chosing not to pay the mortgage when I have the money to do so isn’t something I’m ethically positioned to do. However, when I relocate it will happen eventually regardless out of necessity.
I am trying to do what I think is the right thing to do, absent of the fact that I probably shouldn’t have bought this home to begin with.
Thanks for your concern though.
Bob-
Could you email me the attys info that you work with who practices in California and Florida. At this point, if I am having trouble paying on an investment property, should I stop making payments and keep collecting rent?
Sent you three names.
There are many situations like Tom’s where a foreclosure is not the preferred course of action, even if the credit hit is the same. While the FICO scoring may not show a difference, many future onlookers to a credit report do draw a distinction.
In addition to government agencies, including some sectors of law enforcement, many in the private sector, like financial institutions, make allowances for a short sale or even a deed in lieu, that are not made for a foreclosure. A short sale or deed in lieu requires a a negotiated agreement with all stake holders; simply walking away via a foreclosure does not. There is a difference there that is not accounted for in a FICO score.
Bob, I’m stupified how you could misconstrue my post(s).
I never said to tell homeowners not to do short sales. My entire point is not to exaggerate to a homeowner as to what short sale will do for them or how it will impact (or not) their credit.
Many people, upon hearing their options, prefer, for their own reasons, to short sale. When they make that decision, the file is turned over to me and I negotiate it.
Would you like proof positive that short sale is NOT seen any differently to “future onlookers?” The only future onlookers that matter, of course, are lenders, and they absolutely, positively, without a doubt do not look at short sale any differently than foreclosure or deed in lieu.
Please let me know what you would like to see that confirms this fact.
* You also stated that you get the deficiency removed, however, there is little to no benefit to a short sale over a foreclosure. I would argue that getting the deficiency removed is a big benefit. *
Let me state again–and I hope I’m not misconstrued this time–the ONLY benefit to a short sale is waiver of deficiency but, under certain circumstances, mainly 2nds, the lender couldn’t pursue deficiency anyway after foreclosure. Last I hard, most 2nd lenders aren’t pursuing deficiency.
There is no benefit to short sale vs. foreclosure as far as FICO is concerned.
There is no benefit to short sale vs. foreclosure as far as seasoning for a new loan is concerned.
I don’t know how I can state it any clearer.
See page 75, first bullet mark.
Mortgage accounts, including first liens, second liens, home
improvement loans, HELOCs, and mobile home loans, will be
identified as a foreclosure if there is a current status or manner
of payment/MOP code of “8” – foreclosure, or “9” – collection
or chargeoff.
https://www.efanniemae.com/sf/guides/duguides/pdf/gtu.pdf
If the short sale negotiator can get the short sale lender to mark the account “paid as agreed,” all’s well on the western front. I’ve never seen that happen, but miracles happen every day.
Catherine, no one here exaggerated the benefit to the homeowner.
Not true. Employers matter. Tom told you that his employer has already told him that it matters. Many employers look beyond the credit report, regardless of your experience.
We have had many people call or write that after a foreclosure, the 2nd was pursuing a deficiency. There are comments on this blog to that effect. We have been told first hand by lien holders that they intend to seek a deficiency.
The fact that you are not aware of that or that you have not seen certain things happen doesn’t mean it isn’t true or that it’s a miracle.
You have made your point loud and clear.
I personally went through the short sale process. After contacting HOPE I was able to move forward and contact my lender with different options. It took a long…time to get this all done but bottom line….I was able tokeep a home for my son for a longer period of time vs. starting all over right away. I als was divorced and was out of job for awhile so I bought time by staying contact with my lender… that is very important! Buy yourself some time and research extensively the best way out of this mess.
I was able to list my home on MLS and had a cash buyer within 24 hours, we had the seller make an offer and then we worked on the settled price amount from the lender and once the lender approved the sale it was done!
I do NOT have a foreclosure on my tainted credit history but I DO have peace of mind and what happens in the future will be fine. At least I tried to make the right decisions I also believe if I was to want to purchase another home in the near future I could make it happen! Hang there everyone! BELEIVE IN YOURSELF FIRST!
I missed the comment by Tom that his EMPLOYER makes a distinction. Well, then, that’s a different story, isn’t it?
Here is my situation that hopefully someone can assist me with.
I purchased a home in 2005 as a fixer upper. The loan was an interest only loan that was good for about a year which should of been fine.
Unfortunatly the market turned upside down so I moved into the home and refinanced the loan in 2006. I also got a Heloc at the time of the refinancing as I was going to use that money to move out of state.
Fast foward to the present I’ve almost paid off the Heloc since I didnt move out of state but still want to.
Im still upside down in the mortgage as homes are now selling for 220-250k and I owe between the 2 loans 320k.
My question is what if anything can I do? I’ve been laid off and paying my mortgage out of savings so my account is still current but that will only last for a few more months at best.
I want to leave the state but I dont know how to get rid of the home.
If I do a short sell will I be faced with potentially owing my lender 100K since the home was refinanced?
Will I be faced with paying taxes on the deficiet again because of the refinance?
What would happen if I bought another house prior to doing a short sell? Would they come after me for that property too?
I wonder because my credit took a long time to get in good shape and I know I will take a hit to it but I also know I need to provide housing for my children.
Any help would be greatly appreciated.
Whats really the difference between a deed in lieu of foreclosure and a short sale?
Do you know if this applies to homes that are sold via short sale in Michigan?
Yes, it is.
Rich asked:
Not if you get the lender to agree to forgive the debt.
The lender will send you a 1099-C next year for the amount of debt forgiven. Whether or not it is taxable will depend on a few things. The amount of mortgage debt forgiven that exceeds the original acquisition debt would not be covered by the new law. You should speak with a tax attorney about insolvency to see if that is applicable in your situation.
Not likely, but if you are still laid off, that would make qualifying for a new loan difficult. You would also have to account for the other property. The lender is going to want to know if you are renting it out or selling. If you say that you are renting it, a rental agreement would be required. Most lenders would give you credit for about 75% of the rent, which will impact your qualifying ratios. If you do rent it, you now have a seriously depreciating asset that will likely be harder to sell if rented. If you fake the rental agreement, you have now committed loan fraud - a federal offense.
If you say you are going to sell it, they will want to see an estimated HUD-1, which would bring to light the upside down status of the property and you would have to explain how that is going to be resolved.
A deed in lieu is a voluntary surrender of the deed to the lender, saving them the trouble of foreclosure. A deed in lieu doesn’t work if there are two lien holders, as only one can take the deed back in full satisfaction of the debt. In some cases where there is only one lender, many won’t accept a deed in lieu due to the contract obligations they have with their investors. Wilshire is one such lender that doesn’t want to accept a deed in lieu.
A short sale is a sale of the property where the lien holder(s) agree to release the lien(s) on the property and allow the property to be sold for less than what is owed. They may or may not agree to release the note. They either agree to forgive the debt or require you to sign a promissory note for the difference.
Maria - The Mortgage Forgiveness Debt Relief Act is a federal law and applies to the entire U.S.
If I misunderstood your question, I apologize.
Bob,
Quite a blog; obvious that you know your subject matter inside & out;. Thanks for being so clear with your information, making it easier for us going through this process to understand. I’ve had the same experience as another posting here - time consuming trying to find an atty (in separate state in my case) who will answer my questions. I thought a Real Est Atty would be appropriate, but the one I found from Findlaw appeared to have experience in cases for (a) lenders (b)large corporate business - & not in assisting the individual/homeowner.(Paid him for phone consult with no advice other than ‘work with the lender’)
My situation: Husband was trsf’d back to home state from 5 yr project in S.E. MI (same company). We bought home there in 2004 when houses were over priced & supply low, oblivious to things to come- did much work/refurbishing - house now worth $50k less than balance owed with majority of homes in that area currently sold in distress).
Questions:
1. Much has been … ‘discussed’ - about foreclosure vs short sale - but how does deed in lieu play into the equation? (credit score-wise)
2. Have you found that a VA backed loan is more easily accepted by lender for short sale?
3. 6 months on market; options packet sent to lender 2 mos ago; just rec’d letter from mitigation dept saying in last phase of consideration.
4. Excellent credit/no late pmts til this month; stacking up credit card debt to maintain two households this long, wondering if more consideration given when past due (mortgage thru PHH/Mortgage Lender Assoc).
5. Good idea to have lawyer (or self) make contact with this new/last mitigation dpt - in hopes of presenting best case for short sale?
6. VA backed loan in husbands name only- title in both; in your opinoin, would this fact tilt the scales to one option over another?
7. Instead of continuing with current neighbor realtor -from the old school/handing out fliers & only one picture on realtor.com - contract over now) -what realtor would you recommend to now list short sale with ((recommendations for Oakland Co in MI?) Also, recommendations for real est lawyer in that area who will truly fight for the homeowner?
-Thanks
Since purchasing my home 3 years ago, it has fallen gretly in value close to perhaps 700K. I did refinance and take out very little equity; 16K, so both loans with the same lender. Currently a 5 year I -only on the first. Home was appraised at 820K 12/06
My name only on the loan. Wife is not. This was a stated loan and my credit history is excellent.
I plan to simply let the lender foreclose on the property. Even though we can continue to struggle and with dual incomes pay the monthly mortgage, it seems quite a waste of our income. IN 5 months I would save nearly 21,000
We can simply rent for a year and purchase another home with 10% 40-50K) down on my wifes name, income and credit. 7 years should go by quickly enough, and they can’t take away my credit cards. A short sale is a waste of time and we would end up having to possibly pay taxes on any forgiven debt. I transferred cars into my wife’s name and plan on opening a new Credit card next month as well.
Question: Can the lender come after my income at all or force me to try and pay back any debt, garnish wages etc?
Claire as