The previous post in this series was on 04/23/10, click here to read it.
MORTGAGE, EXPERT, MICHIGAN, BIRMINGHAM, BLOOMFIELD, DETROIT, ROCHESTER, ROYAL OAK, TROY
This series of posts is meant to assist real estate agents in recognizing:
- Legal & Tax Issues their clients are exposed to through a short sale.
- The legal liabilities agents may expose themselves to when representing short sale sellers.
Agents will be dealing with more & more short sales, both on the listing and sale sides, as the Obama administration's HAFA Program gains traction and meets its goal of decreasing foreclosures by turning them into short sales. So, you can either jump on board the "short sale train" or get run over by it.
Now let's look at some common legal & tax issues encountered on short sale transactions. Please share your thoughts and experiences with constructive comments for the benefit of all!
General Legal & Tax Issues on Short Sales
One of the biggest challenges and murkiest, is how to handle the legal and tax issues seller clients must consider on short sales. The major concerns on just about every short sale transaction:
- What is the foreclosure process in the state where the property is?
- Is the foreclosure process judicial or nonjudicial?
- Is the mortgage debt(s) recourse or nonrecourse?
- What are the tax ramifications of 1099's for forgiven debt?
- How should potential deficiency judgments be addressed?
- When should a seller client sign or not sign a Promissory Note to avoid a potential deficiency?
- Is a short sale really the best option for a seller?
- How will the seller's credit be impacted?
- Should the seller file bankruptcy and if so, what type & when?
- What happens if a Foreclosure Sale occurs during the short sale process?
Although some experienced real estate agents might be able to adequately address these issues, the majority of agents engaged in short sales are really in over their heads without even being aware of it.
Let's look at each of these a bit closer.
What is the foreclosure process in the state where the property is?
Keeping track of each state's foreclosure process could be overwhelming. Most agents though, only do business in one state, sometimes two, and so only need to concern themselves with their state.
Some states adhere to Title Theory where a Deed of Trust is used to convey the property deed to a trustee who holds the deed for the protection of the lender. Other states follow Lien Theory, where the homeowner retains the deed to their property but allows lenders to put a lien against the property through a Mortgage. Click here for a list of what each state uses.
Of critical importance is knowing how long the foreclosure process takes in the state where the property is located. Agents should also know if there's a redemption period after a foreclosure sale and how long it is. For more information on state foreclosure laws, click here.
Is the foreclosure process judicial or nonjudicial?
Agents should know if the lender just has to notify the homeowner and advertise the foreclosure sale or if they have to take the homeowner to court to foreclose. This neat map of the U.S. shows which method each state uses. Just hover over the state you're interested in.
Is the mortgage debt(s) recourse or nonrecourse?
Homeowners need to be made aware whether or not a lender can pursue them for a deficiency judgment for the difference between what they owe and what their property sells for at foreclosure. This is a totally separate issue from a 1099 for debt forgiveness and should not be confused with it.
Alaska, Arizona, California, Connecticut, Florida, Idaho, Minnesota, North Dakota, Texas, Utah, Washington
What are the tax ramifications of 1099's for 1099 forgiven debt?
The Mortgage Forgiveness Debt Relief Act, which was extended to December of 2012, exempts acquisition or home improvement debt on one's primary residence from taxation. The limit is $1 million for single or $2 million for joint tax returns. Many agents tell their short sale sellers not to worry about a 1099-C ("C" stand for Cancellation) without asking their client if they pulled money out of their home through a refinance and what they used the money for. That's definitely a liability issue for the agent!
How should potential deficiency judgments be addressed?
This is not a question an agent should discuss with their client. You can talk about possibilities, but should refer your client to an attorney and or CPA. If your seller receives an unexpected deficiency judgment after you sell their home, who do you think they'll sue?
When should a seller client sign or not sign a Promissory Note to avoid a potential deficiency?
A deficiency judgment could affect a seller's credit and may lead to garnishment of bank accounts, paychecks, and even state income tax returns. Sometimes it may make more sense to negotiate a Promissory Note instead. Not something an agent should be doing!
Is a short sale really the best option for a seller?
There are many internet articles complaining about agents talking sellers into a short sale when a loan modification or other option would have been in the client's better interest. Sometimes staying in the property for as long as possible with no payments, is a homeowner's best course of action. Other times, given FNMA's recent clarification of waiting periods for qualifying for a new mortgage, a short sale may be best. If your client hasn't explored their options, you could be exposing yourself to a potential lawsuit if you don't properly inform them of the alternatives.
How will the seller's credit be impacted?
A lot of real estate experts were proven wrong when Fair Isaac Company, the developer of the infamous FICO credit scoring model, revealed how short sales, deeds-in-lieu and foreclosures affect a borrower's credit scores. Two important highlights: they all affect scores approximately the same and people with higher scores will be affected more. Almost every agent I've ever spoken to about short sales has told me with conviction that a short sale is better for a seller's credit than a foreclosure. I don't think "oops" is going to get them out of a lawsuit from an upset client.
Should the seller file bankruptcy and if so, what type & when?
Often a homeowner short selling their home has lost their job or is buried in debt with no realistic hope of getting out of their situation. Combining their situation with the probability of getting hit with a deficiency judgment may mean they'd be better off filing bankruptcy. Agents should make sure they don't give legal advice in these situations and don't get overeager to just list a property in pursuit of a commission check.
What happens if a Foreclosure Sale occurs during the short sale process?
Given all the various state foreclosure laws, this could be ugly. I've witnessed more than one agent telling a seller they could push a foreclosure sale back and not to worry. How do you spell misrepresentation? Proper disclosure must occur - even if it costs a potential commission check.
Well, how am I doing so far? Have I gotten your attention and enticed you to come back for more? Do you even want to read more or are you just going to swear off short sales altogether?
I recommend you find the best & most knowledgeable real estate attorney you can in your area and take them to lunch to discuss all these issues. From personal experience I warn you against just settling for an attorney you already know or one that claims they know what they're doing. Many attorneys are no more experienced than you are at short sales and are learning on the fly - and may do so at you & your client's expense. Seek out experienced attorneys or ones that are exerting a lot of effort to educate themselves quickly and are honest about it.
NOTE: if you're the impatient type and don't want to wait to read the series as it's published, I'll send you the complete whitepaper for the series when you do ALL of the following:
- Post a constructive comment on one of the posts in the series
- Reblog one of the posts in the series
- Make me an associate of yours on ActiveRain
- Join my Fanpage @ www.facebook.com/TheLendingEdge and send me a message there requesting the whitepaper with your email address.
If you're a Michigan agent, I'd also very much appreciate you joining a new AR group specifically for Michigan real estate professionals willing to share marketing and social media ideas with each other.
Thanks for reading and I hope you spread the word.
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Drew Sygit: CMPS, CMC, CRMS, CMLO, CALO, MBA, NAMB/MAMP Instructor & Speaker
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Ellen Dittman, Watson Realty Corp.
904 535 1199
Short Sale Help!
Watson Realty Corp.
153 Blanding Blvd
Orange Park, FL 32073
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