The Hidden Threats To A Short Sale
A short sale is a sale of real property where the proceeds
are insufficient to pay off the balance owed on the
mortgages. Real estate agents play an important role in
providing only part of the information you must have in
order to give informed consent to a short sale.
Imagine the following scenario. You sold your home for
$270,000 last year. You had a first mortgage of $400,000
and a second mortgage of $100,000 for 100% financing
on your first home. Your real estate agent negotiated for
$130,000 cancellation of debt (COD) on the first
mortgage and persuaded the second mortgage to allow
the sale to close if they received $5,000.
Would you have agreed to a short sale if you knew that
the Internal Revenue (IRS) and the state would come
after you for $50,000 to $60,000 in taxes on the COD?
Would you have given consent to a short sale if you knew
the second lender would sue you for the $95,000
deficiency after your short sale escrow closed?
Agents will almost always have you sign the California
Association of Realtors
®
Short Sale Addendum or a
similar form from your state or your agent's company.
Typical Addenda state something similar to, “Seller is
advised to seek advice from an attorney, certified public
accountant or other expert regarding such potential
consequences of a short sale.” Addenda also state that
real estate brokers/agents are not qualified to offer credit,
legal, and tax advise. Even if you signed such a form,
you might have a cause for legal action against an agent
and his broker for the taxes, lawsuits for deficiencies, and
damages that you face after a short sale of your property.
Did your agent's improper advice, misrepresentations,
undue influence, or coercion during a time of a weak
financial condition and duress cause you to sign the
Addendum and move forward on a short sale without
competent legal and tax advice? You may not have had
true legal capacity to give informed consent. Speak to an
attorney if you believe this happened to you. Agents who
set personal needs above yours should be held
accountable and perhaps pay the taxes, deficiencies, plus
damages. In the example above, you might have sold the
property in a short sale and also protected yourself from
the nightmare of IRS and a lawsuit if you had received
the necessary information.
Examine the tax issues. If you borrow money and the
lender cancels or forgives debt, such as the $130,000
cancellation of debt (COD) in the example above, you
might have to pay taxes on the COD. Lenders report the
COD to you and IRS on Form 1099-C. You are
responsible for the tax even if you do not receive the
1099-C.(See IRS Publication 4681). There are
exceptions to the taxes.
The Mortgage Forgiveness Debt Relief Act of 2007
generally allows taxpayers to exclude COD on a
principal residence from income. The COD must be on
debt used to purchase your home, not a refinance. This
applies to debt forgiven from 2007 to 2012. Up to $2
million of forgiven debt can be excluded ($1 million if
married filing separately).
Legal cancellation of debt through a bankruptcy protects
the average individual debtor from tax consequences.
IRS Code Section 108 excludes the discharge of debt in
bankruptcy from its definition of cancellation of debt
income. However, COD might be treated as if it were
income for tax purposes if the debt occurs outside of
bankruptcy. If you have received an IRS 1099(c) on a
debt discharged in a bankruptcy case, you can file Form
982 to inform IRS that the sum on the 1099 should be
excluded from your income because of your bankruptcy.
Insolvency is another exception to the cancellation of
debt tax. If you are insolvent when the debt is canceled,
some or all of the canceled debt may not be taxable to
you. You are insolvent when your total debts are more
than the fair market value of your total assets.
Tax issues are complex. Consult with qualified tax
advisors before a short sale, not after.
The California Code of Civil Procedure (CCP) 726(a)
states, “There can be but one form of action for the
recovery of any debt or the enforcement of any right
secured by mortgage upon real property or an estate for
years therein.” This means the lender with a mortgage on
your home must
in California before they can pursue any other remedy.
California has two foreclosure procedures, non-judicial
foreclosure and judicial foreclosure.
2 Of 2 Copyright
elect one of the foreclosure proceduresÓ 2009 by Joe VeraNon-Judicial Foreclosure
foreclosure not brought before a court. In a non-judicial
foreclosure, a Notice of Default (NOD) is recorded and
three months later, a Notice of Sale (NOS) may be
recorded. Twenty-one days after the NOS, the property
can be sold at a public auction. Up to five days prior to
the Trustee Sale date (TS) the borrower may cure the
default by payment of the delinquent amount plus costs.
Under the new California Foreclosure Prevention Act in
effect from March 16, 2009 to January 1, 2011, lenders
foreclosing on certain loans are prohibited from giving a
notice of sale until the lapse of at least 3 months plus 90
days after the filing of the notice of default. A loan
servicer can obtain an exemption from this requirement
by demonstrating that it has a comprehensive loan
modification program.
If the property is not sold to a third party at the auction
sale, the lender may acquire title to the property. The
advantage of the non-judicial foreclosure to the lender is
that it can be completed in three months plus twenty-one
days under ideal conditions. The disadvantage is that
absent of borrower's fraud, waste, or malicious
destruction of the property there is no further remedy, no
personal recourse to the borrower for the lender that
forecloses non-judicially.. This is the most common
procedure used for foreclosure of a home.
In a
sell a property in order to recover on a mortgage in
default. With a judicial foreclosure not only can the
lender sell the property to recover their money, they can
also seek to have the court render judgment against the
borrower in favor of the lender for the balance of the
lender’s claim. However, under the California law,
deficiency judgments are not permitted in the situation
where the seller has carried back a loan on the property
that was bought by the purchaser.
A special note to homeowners: Loans obtained to
purchase one to four units that are owner occupied are
protected from a deficiency judgment. When a
homeowner refinances the purchase-money loan on their
home, the liability of the homeowner completely
changes. The code does not protect the property owner
from personal recourse when this type of loan is
refinanced.
In a short sale, the lender does not
CCP 726 as discussed above. A short sale removes some
or all of the protection the codes provide. Legal counsel
might say it would have been better for the property to go
to foreclosure rather than consent to a short sale outside
of bankruptcy!
When a senior lender forecloses and the successful
bidder at the foreclosure sale is a third person (someone
other than the borrower or the lender), the junior secured
lender (any lender that is subordinate or subsequent to
the claims of a prior lien, for example, a second mortgage
is a junior lien) may be able to file a lawsuit against the
borrower to collect on the unsecured promissory note and
not be limited by the protection afforded a borrower at a
foreclosure sale. This situation is commonly referred to
as a “sold-out junior lienholder” If the junior lien is not
securing money used to purchase the property (purchasemoney),
after the foreclosure of the senior lien, the junior
lienholder can sue the borrower and obtain a judgment
against all persons that executed the note.
There are possible protections against COD taxes and
deficiencies in bankruptcy. It is this writer's opinion that
you must consult with a bankruptcy attorney and
qualified tax advisor before participating in a short sale.
Real estate agents are important, but only part of the
team that you need. There are many good real estate
brokers and agents that will work with an attorney and
tax advisor in order to help you determine what is best
for you.
Joseph Vera is a real estate broker, consultant, and
lecturer with 33 years experience assisting commercial
and residential property owners facing cash flow
deficiencies, foreclosure, bankruptcy, cancellation of tax
issues, lender liability issues, and dissolutions of business
entities. He offers free seminars to distressed
commercial and residential property owners. He can be
reached through
4474.in California simply means ajudicial foreclosure a lender may use court action toelect the remedy inwww.joseph-daniel.com or (800) 211-
