Short Sales From a Tax Perspective - Myth vs Truth
Short sales, principal reduction loan modifications, deeds in lieu and foreclosures all present unique tax consequences, and they vary from one person to another. Much of what we are hearing from clients, which they are hearing from others, is either not true or not true for them.
Here are my Top 10 Myths --and the corresponding truths-- in this area. With a few exceptions, the myths stem from a grain of truth. But just like the game of telephone, the fact that it began as truth doesn’t mean what you’re hearing is reliable.
Myth #1 - “I won’t owe any income tax because this is homestead property.”
This myth began with the passage of the Mortgage Debt Forgiveness Relief Act (“MDFRA”) in December 2007, which does provide some relief to those taxpayers who face debt forgiveness (which would otherwise be taxable) relating to their real estate.
There are significant limits on the relief, however. Here are the requirements:
- The debt applies to a principal residence as defined in Internal Revenue Code Section 121. (Principal residence is NOT necessarily homestead property in Florida.)
- The debt was used to acquire, construct or substantially improve the principal residence (as defined in Internal Revenue Code Section 163(h)).
- The amount of the forgiven debt is not included in the taxpayer’s income, but it reduces the taxpayer’s basis in the property.(This will increase the gain on the sale if the property is sold, and that gain is taxable).
- The amount of the forgiven debt also reduces, dollar for dollar, the amount of gain that can be excluded under other provisions (IRC Section 121).
- Only the first $2 million of forgiven debt is excluded from income.
A principal residence for IRS purposes is not the same as homestead property under Florida law. A principal residence is property which has been owned and used, during the 5-year period ending on the date of the sale or the debt forgiveness, as the seller’s primary residence for a total of at least 2 years. Often, a seller did not use the property as a principal residence for 2 years or more during the prior 5 years, even if he declared it as homestead property. If it’s not a principal residence under this definition, there is no tax relief under the MDFRA.
The other requirement that is often not met is the use of the debt to acquire, construct or substantially improve the principal residence. Many property owners refinanced to access cash for reasons unrelated to the property: they started a business, paid off a car loan or credit cards, or took a vacation. Any part of the funds used for those purposes remains taxable. However, if the proceeds were used to add a pool, renovate a kitchen or replace the roof, that portion of the debt forgiven will be excluded from taxable income.
Myth #2 - “I’ll have a loss on the property, so I don’t need to worry about tax.”
Capital losses resulting from the sale of the property will not offset the income resulting from the forgiveness of debt. Also, sellers often believe they have a “loss” on their property when in fact they don’t – selling it for less than you owe isn’t the test. If your basis is less than the debt forgiven, you can actually have a gain. This often happens in the short sale situation, due to the reduction of basis (see 1c above).
Myth #3 - “I can use the $500,000 capital gain exclusion to wipe out any taxable income from the short sale.”
The $500,000 exclusion (for married filing joint, $250,000 for single taxpayers) is a capital gain exclusion only. Income from debt forgiveness is ordinary income, not capital gain. This exclusion is only helpful if a capital gain results from the reduction in the basis of the property. But beware, (as mentioned in 1d above) the amount of the forgiven debt which is excluded from taxable income also reduces the amount of gain that can be excluded under this provision, dollar for dollar.
Myth #4 - “I’m in a low tax bracket, so the tax won’t be that much.”
Before the transaction in question, the seller probably was in a low tax bracket. If the debt forgiven is large (and it’s not unusual these days to see amounts of $50,000-$150,000 and higher), this increases the seller’s taxable income by that amount. It’s like getting a big fat paycheck that you never see, and it puts many sellers into higher tax brackets than their historical rates.
Myth #5 - “I have no assets, so I’m insolvent and don’t need to worry about the tax consequences of a short sale.”
This is true as far as it goes: Section 108 of the IRC indeed provides for excluding forgiven debt from income to the extent the seller is insolvent. However, just because a seller is upside down on their property doesn’t mean they’re insolvent for this purpose. The extent of insolvency for IRS purposes is the difference between the outstanding liabilities and fair market value of the assets (this is all assets, including protected assets such as retirement accounts) owned by the Seller on the date of the short sale. It is virtually impossible to reach a conclusion on insolvency for this purpose without a detailed analysis of all of the seller’s assets and liabilities, including those unrelated to the property, as well as the basis reduction that would occur in the short sale.
The good news on this one is that, unlike the MDFRA, the insolvency exclusion applies to investors. This is an important aspect to explore for them particularly.
Myth #6 - “I heard that the IRS isn’t going after people due to the economic climate.”
Ok, this one doesn’t stem from a grain of truth; it’s just wishful thinking. The IRS is actually increasing its enforcement and collection efforts in the current economic climate. It’s primary purpose is to collect revenue; and the government needs revenue as much as anyone else these days.
Myth #7 - “I’ll just tell the lender that I don’t want a 1099.”
Good luck with that. The 1099-C requirement is not negotiable: it’s the law. If the debt is forgiven, the tax liability has been generated. The lender must report it, and so must the property owner (even if they don’t receive a 1099-C by January 31 of the year following the short sale). Sellers can be subject to a 25% reporting penalty if they don’t report the debt forgiveness; this is not one to be taken lightly.
Myth #8- “I heard on the news that there is no tax on short sales anymore.”
See Myth #1. And stop watching the news.
Myth #9 - “I’ll just let the property go into foreclosure, rather than do a short sale, to avoid the taxes.”
This wouldn’t necessarily help you. The tax is the same regardless of how the debt forgiveness comes about: a short sale, principal reduction loan modification, deed in lieu of foreclosure or foreclosure all have the same effect. The only potential difference is the amount of the debt forgiven. For example, default interest, attorney’s fees and costs continue to add up during a foreclosure, which might be avoided or reduced in a short sale, typically making the unpaid balance of the loan (and resulting debt forgiveness) in a foreclosure higher than if a short sale were completed.
Myth #10 - “If I end up owing tax, I’ll just file bankruptcy.”
Chances are, you’ll still owe the tax. Income tax is not typically discharged in bankruptcy. While there are a few exceptions, most will not apply in these cases.
The tax implications of foreclosures and short sales are more complex than mass media would lead us to believe, and there is considerable misunderstanding among property owners as to what the rules are and how they would apply. Hopefully we can help to dispel the myths by steering our clients toward tax professionals who can help and help them plan appropriately.
-JoAnn M. Koontz, Esq., CPA
Yesner & Boss, P.L.
Credits When Dealing With the New GFE and Settlement Statement
With the passage of new amendments to both RESPA (Real Estate Settlement Procedures Act) and HUD rules and regulations, short sale lenders and negotiators may get confused as to why we reflect credits on page 1 of the settlement statement.
Pursuant to §3500.7(d) “The loan originator must prepare the GFE in accordance with the requirements of this section and the Instructions in Appendix C to this part.” (emphasis added). Click here to see page R-4.
Appendix C requires that the loan originator include a charge on the GFE for “Owner’s Title Insurance” in Block 5 of the GFE, and “Government Recording Charges” in Block 7 of the GFE. Click here to see page R-18 and R-21.
In some parts of Florida, including the Tampa Bay Area (Pasco, Hillsborough, Pinellas and Polk Counties) both Owner’s Title Insurance and Government Recording Charges related to the deed are paid by the Seller of property. However, the GFE requires these costs be shown as Buyer costs.
To remedy this, see Appendix A to Part 3500 which states as follows:
As a general rule, charges that are paid for by the seller must be shown in the seller’s column on page 2 of the HUD-1 (unless paid outside closing), and charges that are paid for by the borrower must be shown in the borrower’s column (unless paid outside closing). However, in order to promote comparability between the charges on the GFE and the charges on the HUD-1, if a seller pays for a charge that was included on the GFE, the charge should be listed in the borrower’s column of page 2 of the HUD-1. That charge should also be offset by listing a credit in that amount to the borrower on lines 204-209 on page 1 of the HUD-1, and by a charge to the seller in lines 504-509 on page 1 of the HUD-1. (emphasis added). Click here to see page R-7.
Therefore, in those areas of Florida, including Tampa Bay, where the seller pays certain closing costs pursuant to the contract, which are listed as buyer costs on the GFE, those costs must be shown as a credit to buyer and seller on page 1 of the settlement statement. To do otherwise would violate Federal Law related to real estate closing procedures.
How Does Bankruptcy Affect My Credit?
Bankruptcy and its affect on credit is unquestionably the biggest concern of most bankruptcy clients. The ironic aspect is that often bankruptcy, especially Chapter 7 bankruptcy, is the quickest road to credit recovery.
Everyone knows that credit score dictates a person’s ability to borrow. What many people do not realize is that credit score is only one element of lending criteria.
Lenders will tell you that credit score will “open the door” to getting a loan, but the single most important lending criteria is DTI, or, debt to income ratio.
DTI, in basic terms, is the percentage of a person’s monthly gross income that is utilized to pay their debts. If a person’s DTI is too high, that too much of their income is used to service debt, lenders will be very reluctant to continue to lend money.
Again, the irony of credit is that a person can have a credit score of 750 (which is excellent and would indicate a good potential borrower) but will be denied a loan because their high DTI ratio. For example,
Bob has a FICO credit score of 750 and DTI ratio of 85%. Bob wants to borrow money to purchase a vehicle. While Bob will be “pre-approved” based on credit score alone, the vehicle lender will likely decline Bob’s loan. Based on Bob’s DTI, the lender is concerned that Bob cannot continue to service his debts and will therefore be a substantial default risk.
I use the term ironic in describing credit because credit score is very often just a façade. While Bob’s score is high, it is still somewhat worthless – really no different than a person with a 550 credit score. Why? NEITHER CAN BORROW MONEY!!
Bankruptcy is often a very quick credit recovery because a person’s DTI is instantly and substantially reduced through the bankruptcy. Bankruptcy discharges the debt – instantly improving the DTI ratio, which again, are the single most important criteria evaluated by lenders when taking loan applications.
Christopher W. Boss, Esq.
Yesner & Boss, P.L.
How Does Bankruptcy Affect Child Support?
There are two facets to child support and alimony in a bankruptcy context; both the payment and receipt of child support and alimony.
Sometimes, child support and alimony debt can become so burdensome that the parent or ex-spouse believes that bankruptcy is the only way out. Bankruptcy is a bad alternative to eliminate child support or alimony; a family law court would be a better forum to have those obligations reduced, if appropriate. Bankruptcy might help reduce other unsecured debts that will allow the child support and alimony obligations to be more affordable however.
When the bankruptcy is filed, the automatic stay halts all collection activities, except those actions to establish paternity, and actions for domestic support, child custody or visitation. In addition, the automatic stay has no effect on the reporting of overdue child support to any consumer reporting agency.
Both domestic support obligations and debts owed to a spouse or former spouse pursuant to a divorce or separation agreement are non-dischargeable in bankruptcy. Therefore, those debts remain even after the bankruptcy is completed.
Finally, in order to file for bankruptcy protection, child support and alimony obligations must be current and must be kept current during the bankruptcy case.
Therefore, bankruptcy is ineffective as a tool to eliminate child support and alimony obligations, although it might be a good alternative to reduce other debts, thereby making child support and alimony easier to afford.
What happens, however, when the person receiving child support or alimony is forced to file for bankruptcy protection? For those bankruptcy filers that receive child support and alimony, both federal law and Florida law allow the receipt of child support and alimony to be exempt from creditors and from the bankruptcy trustee. Therefore, the receipt of child support and alimony has little effect on the amount the debtor may have to pay to unsecured creditors during the pendency of the bankruptcy case.
Shawn M. Yesner, Esq.
Yesner & Boss, P.L.
New Law Requires All Loan Modifiers to be Licensed but Lawyers Representing Clients Are Exempt
On January 1, a new law took effect requiring that private businesses offering loan modification services to Florida homeowners must be licensed by the state of Florida. However that law does not apply to lawyers who are representing clients though a bona fide law office as outlined under the Rules Regulating the Florida Bar.
This law passed by the Legislature requires that all private companies and individuals must first be registered with and licensed by the state in order to offer help to troubled homeowners working with lenders. This law hopes to eliminate massive fraud that has taken place around the state, many of which have resulted in the Attorney General filing civil lawsuits on behalf of consumers.
The Florida Bar and the Office of Financial Regulation agreed that when there is an attorney-client relationship between the homeowner and the provider of modification services established by the attorney and not a third party, then the relationship is properly governed by The Florida Bar and the Rules of Professional Conduct. If there is no such attorney-client relationship, then the loan modification “mill” is just a business and should be licensed and regulated by OFR like any other nonattorney business within its regulation — even if attorneys own or are employed by the nonattorney business. Further, the bar took the position and the agency agreed that nonattorney staff members in a law office would not have to be licensed by OFR as the attorney remains responsible for their conduct.
Personal Bankruptcy Filings Rising Fast in Florida’s Middle District
The number of citizens in the Middle District of Florida filing for bankruptcy rose by nearly 45% this past year. This drastic increase in filings is largely due to the number of foreclosures and unemployment.
Almost twice as many people are filing for Chapter 7 bankruptcy, which liquidates assets allowing filers to pay off some debts and absolving them of others. This figure is significant due to the number of federal bankruptcy laws enacted in 2005 with the purpose of encouraging Chapter 13 filings. Chapter 13 filings require filers to reorganize their debt and enter into repayment plans in exchange for keeping certain assets.
The idea behind the 2005 bankruptcy laws was to make it harder for people to completely dispose of their debt, particularly for Chapter 7 filings. In order to segregate those who had the means to repay their debt and those who did not, a “means” test was implemented. If the test establishes that a person is financially capable of satisfying at least part of the debt after it is restructured, they will not qualify for a Chapter 7 filing.
All together, personal bankruptcy filings in central Florida rose to 61,009 as of December 2009, according to United States Bankruptcy Court for the Middle District of Florida statistics. This figure is up 45% from 2008. This is also the highest number reported since 2005 when there was a dramatic increase in filings due to the new legislation which was about to take effect.
Chapter 7 filings were up more than 58% as of December 2009, compared with December of 2008, according to the Middle District. December is the most recent month with data available. Chapter 13 filings rose by 17% and accounted for 25% of the 2009 filings as of December. Judging by these numbers, it does not appear that the 2005 legislation is very effective or is achieving its purpose.
The massive amounts of foreclosures and the unemployment rate have caused people to file for bankruptcy who wouldn’t have otherwise. Nationwide statistics have shown more highly educated and affluent citizens have turned to bankruptcy. Some experts believe that bankruptcies peaked at some point in 2009, but it does not appear that the number of bankruptcy filings is going down whatsoever.
When Does My Bankruptcy End?
I am often asked, “how long will this take – when will my bankruptcy end?” The answer depends on the congestion of the court’s docket and what type of bankruptcy is filed. Sparked by the great economic disaster of 2008 bankruptcy filing in the Middle District of Florida is up almost 50% from 2008, topping out at almost 58,000 according to the Tampa Bay Business Journal. The increase in filings in the Middle District of Florida is the second largest in the nation behind the Central District of California.
Despite the increased number of filings, a common chapter seven bankruptcy case in the Middle District of Florida takes anywhere from three to six months from the filing date until the date of discharge. Discharge being the conclusion of a bankruptcy case i.e. the Debtor is alleviated of the debt obligations. Considering the overwhelming number of filings and the second busiest bankruptcy court in the country, a Debtor can make their way through a chapter seven in a reasonable amount of time.
However, if a debtor files a chapter thirteen bankruptcy, the time frame is much different. In a chapter thirteen bankruptcy, the Debtor makes a monthly repayment to the Trustee over the life of a thirty-six or sixty month repayment plan. Once the Debtor makes the last payment in their chapter thirteen plan, the Debtor is then discharged. Depending on which plan, a chapter thirteen bankruptcy takes at least three years before discharge and in many cases five years before discharge.
Vincent C. LoBue, Esq.
Associate Attorney
Yesner & Boss, P.L.
The Bank Said My Foreclosure Sale Will Be Next Week! Help!
We often receive frantic calls from homeowners because they’ve called the bank after having been served with a foreclosure lawsuit, only to hear from the bank’s representative that “Your foreclosure sale is December 22, 2009.” “How can that be?” the borrower thinks, “The lawsuit was first filed on November 12, and I’ve received nothing by mail from my lender.” In this blog, we will explain why this happens and what borrowers can do about it.
When the bank refers a case to its attorney, they require that attorney to stay within certain timelines. The speed and efficiency within which the plaintiff foreclosure firm can complete the foreclosure action, or the average time within which they can complete all cases referred to them, determines how many cases will get referred to that firm above their competitor plaintiff firms.
Although all lenders have their own internal timelines, one example is:
File Foreclosure
|
5 days from receipt of referral from the lender
|
Service of Process complete
|
30 days from filing
|
File Motions for Default & Judgment
|
30 days from Service Complete
|
Schedule Judgment Hearing
|
30 days from Filing Motions
|
Foreclosure Sale
|
30 days from Hearing
|
Certificate of Title Issued to Lender
|
10 days from Foreclosure Sale
|
Tenants / Homeowner Evicted
|
5 days from Certificate of Title
|
Pursuant to this timeline, the lenders expect that the foreclosure will be complete between 140 and 150 days. Further, the lender automatically creates this timeline upon referral of the case to its counsel so that they can track and monitor their attorneys’ speed and efficiency. Accordingly, the lender knows that if the file is referred on January 1, 2010, then the foreclosure sale should be on May 5, and all occupants evicted by May 21.
The problem is that each individual foreclosure action will vary in length based upon a number of factors: the judges’ or courts’ calendars (given the volume of foreclosures today, some judges have a wait time of between 3 and 4 months to get time on their hearing calendar); the number of defendants and their ease in being found (the more defendants or defendants who live out of the county where the case is pending may increase the time needed for service of process); foreclosure sale dates granted by the judge of 60 days or longer; and attorneys who file motions to challenge the lender’s foreclosure action on any number of legal grounds. When the actual timeline varies from the lender’s anticipated timeline, conversations like the one described above occur between lender and borrower because the lender’s computer system shows the anticipated timeline rather than the actual timeline.
What can borrowers do about this? First, do not panic. Second, consult with an attorney who is familiar with the foreclosure timeline and the lenders’ practices to come up with a plan to either save your home, or get rid of the house with minimal liability owed to the lender. Finally, inquire with an attorney as to whether this practice by the lender is a violation of the Fair Debt Collection Practices Act (FDCPA) or Florida’s Consumer Collection Practices Act (FCCPA). Pursuant to those two laws, it is improper for the lender to misrepresent any facts about your debt in furtherance of the collection of a debt. Clearly, telling a borrower that their foreclosure sale is set for a date certain that is physically impossible given the Florida Rules of Civil Procedure would violate both the FDCPA and FCCPA. However, as these types of cases are very fact specific, you should consult with an attorney before coming to any conclusion that the lender’s actions violate either of those two laws.
If you know someone who is facing foreclosure, and they contact the lender for information and the lender gives them a “foreclosure sale” date that seems unreasonable, it likely is based on an anticipated rather than actual timeline. That homeowner should follow up with the Clerk of Court, or a Florida licensed attorney before jumping to the often inaccurate conclusion that the sheriff is going to take their house away sooner than Florida Law allows.
Obama Guidelines Aim to Ease Short Sales
In an effort to assist financially troubled borrowers attempting to sell their home, the Obama administration has laid out guidelines designed to encourage the use of short sales allowing the borrower to sell their home for less than what is owed on the loan. In effect this program also makes it easier for borrowers to voluntarily transfer ownership of properties through a "deed in lieu of foreclosure."
The program’s official name is the Home Affordable Foreclosure Alternatives Program (HAFA), and its part of the existing Home Affordable Modification Program (HAMP). HAFA will apply to loans not owned or guaranteed by Fannie Mae or Freddie Mac, which cover over half of all U.S. mortgages; however, Fannie and Freddie will issue their own versions of HAFA in coming weeks.
This is the latest addition to the Obama administration's $75 billion foreclosure-prevention plan, which includes incentives for mortgage companies and investors to rework troubled loans. The government first said in May that it would include short sales in the program, but it has taken months to finalize the details.
Under this plan, if a home is sold for less than the amount of the mortgage the borrower will receive $1,500 and the Mortgage-servicing companies will receive $1,000 upon completion of the short sale. The program is open to borrowers who may be eligible for the government’s loan-modification program but don’t end up qualifying, or are delinquent on their modification, or request a short sale or deed-in-lieu transaction.
Also under these new guidelines, second-mortgage holders can receive up to $3,000 of the sales proceeds in exchange for releasing their liens. Investors who hold the first mortgages, meanwhile, can collect up to $1,000 from the government for allowing such payments.
Of Critical importance, borrowers who complete a short sale under the program must be "fully released" from future liability for the debt, according to the HAFA guidelines.
While the goal of the HAFA is to simplify the process in the hopes of increasing the number of short sales and “deeds in lieu of foreclosure” the rules can be a bit complex, and it comes with 43 pages of guidelines and forms. To review these guidelines and forms please click here.
This program will not take effect until April 5, 2010 but servicers may implement it before then if they meet certain requirements.
How Do Common Credit Issues Affect FICO Scores?
A common question we are asked during our client consultations is “How will a bankruptcy, foreclosure, and/or short sale affect my credit score?” One common answer is “We have no idea, but there is no way to protect your liability without some negative impact on your credit, which can recover over time.”
Probably a bad answer, but now we have a new answer.
On Thursday, November 26, 2009, FICO (Fair Isaac Corporation) revealed its “damage points” information. Previously, the company revealed only broad categories of factors influencing a consumer’s credit score, rather than the specific number of points at stake for credit mistakes.
FICO is the company that pioneered consumer credit scoring, and is most familiar to all consumers. FICO assigns a three-digit number from 300 to 850, depending upon how well consumers handle credit. Other companies offer consumer credit scoring systems, but FICO’s version is the most well-known and most widely used by lenders in determining whether a consumer can borrow, how much, and at what interest rate.
As the table at left demonstrates, those consumers with excellent credit (780 and above) may suffer a bigger point drop than those with an average credit score (680 points). For example, someone with excellent credit who has a 30-day late payment will suffer a FICO score drop of between 90 to 110 points, whereas someone with average credit will suffer a smaller FICO score drop of between 60 and 80 points.
Unfortunately, given the high rate of foreclosures, record-filings in bankruptcy, short sales, unemployment, and all of the other economic woes outside the control of many consumers, it is difficult to avoid these drops in credit. However, given the information provided last week by FICO, when faced with two difficult decisions it is now easier for consumers to take the least-worst decision, if FICO score is more important to the consumer than liability to any particular creditor.
- Shawn M. Yesner, Esq.
Congress Extends Homebuyer Tax Credit Until April 30, 2010
On November 5, 2009, Congress voted to extend the homebuyer tax credit program until April 30, 2010. The extension continues the $8,000.00 tax credit to first time homebuyers, and includes an additional credit for current homeowners of $6500.00. Further, by extending the Homebuyer tax credit, the Florida Homebuyer Opportunity Program will continue to provide loans to first time buyers for down payment and closing costs. The chart below provides a comparison of the benefits to homeowners under the original act and the new benefits under the extended program:
FEATURE
|
Jan 1 – Nov 30, 2009
Rules as enacted February 2009 |
Nov. 7 – April 30, 2010
Rules as enacted November 2009 |
First-time Buyer
Amount of Credit |
$8000
($4000 married filing separate) |
$8000
($4000 married filing separate) |
First-time Buyer
Definition for Eligibility |
May not have had an interest in
a principal residence for 3 years prior to purchase |
Same |
Current Homeowner
Amount of Credit |
No Provision
|
$6500
($3250 married filing separate) |
Effective Date
Current Owner |
No Provision
|
November 7, 2009
|
Current Homeowner
Definition for Eligibility |
No Provision
|
Must have used the home sold
or being sold as a principal
residence consecutively for 5 of the previous 8 years |
Termination of Credit
|
Purchases after November 30,
2009.
(Becomes April 30, 2010 on Date of Enactment.) |
Purchases after April 30, 2010 |
Binding Contract Rule
|
None
|
So long as a written binding
contract to purchase is in
effect on April 30, 2010, the
purchaser will have until July 1, 2010 to close. |
Income Limits
(Note: Increased income
limits are effective as of date of enactment of bill) |
$75,000 – single
$150,000 – married
Additional $20,000 phase out |
$125,000 – single
$225,000 – married
Additional $20,000 phase out |
Limitation on Cost of Purchased Home |
None
|
$800,000
November 7, 2009 |
Purchase by a Dependent |
No Provision Ineligible |
November 7, 2009 |
Anti-fraud Rule |
None
|
Purchaser must attach
documentation of purchase to tax return |
An IRS 1099-C Form Does Not Mean Debt Is Discharged
A third circuit bankruptcy case recently decided that Form 1099-C does not establish that debt is discharged. A creditor typically issues a Form 1099-C to a debtor in bankruptcy to show cancellation of debt. The credit union in the case In re Bononi, had sent the Chapter 7 debtor zero-balance account statements and an IRS form 1099-C for “cancellation of debt.” After receipt of the form and the account statements, the debtor received money from the settlement of a personal injury action. The court found that despite the statements and the 1099-C form, the debtor still had an obligation to pay on the past debt. Additionally, the court found that even if a creditor issues a 1099-C form, the form does not prohibit the creditor from pursuing collection of the old debt. Only a discharge from the Bankruptcy Court has the effect of canceling the debt and removing the debtor’s liability for the debt. In re Bononi, 19 CBN 864.
Commercial RE Distress Will Have A Big Impact on Housing
Below is a recent article written by John Burns Real Estate Consulting Vice President, Lesley Deutch regarding the potential impact on the housing market as the Commercial Real Estate Market becomes distressed.
We were lucky enough to present at an all day Commercial Real Estate Symposium at the Fed, where the preeminent industry experts from each real estate sector shared what is occurring in their industry. Prior to the meeting, we had been estimating that banks would not recover 20% of the commercial real estate loans outstanding. Now, we feel that the recovery will even be less.
This distress will certainly have an impact on housing, and one that will be both good and bad at the same time.
• Good: As soon as commercial real estate distress hits the banks in full force, solvent banks will need to dispose of residential assets to concentrate on commercial real estate distress. This will create land buying opportunities in the next several months. Builders acquiring land for cheap means the beginning of a recovery.
• Bad: Banks with high commercial real estate exposure are unlikely to lend to the residential sector, and many of these banks will be lucky to survive at all. To determine whether or not your bank has significant commercial real estate exposure, check out their balance sheet, which is usually in the investor section of their website.
The Problem
Property values are now down 35% from the peak, according to Moody's. We think prices will fall even more as leases expire and the tenants lease less space at a lower rent.
Why is this a problem? Commercial banks own nearly 45% of mortgage debt outstanding. By comparison, the banks own only 21% of the single-family mortgage debt outstanding.
The insolvency of several thousand banks will overwhelm the understaffed regulatory system and it will take at least 3 more years for a healthy banking system to emerge. We expect the government to intervene even more than it has in order to save the US banking system. When this occurs, it could indirectly benefit home builders by providing great distressed land buying opportunities, and by shoring up the banks so the better banks can start lending again soon.
Rise In Foreclosures Ensures That Housing Supply Will Continue
According to the Center for Responsible Lending, a nonpartisan watchdog group based in Durham, North Carolina, there are more than 6,600 home foreclosure filings per day in the US, and with two million this year alone, the flood shows no signs of abating. Foreclosures, which started with subprime borrowers, have now moved on to the much bigger prime loan market on the back of mounting unemployment. Michael Barr, the Treasury Department's assistant secretary for financial institutions, said in congressional testimony last month that more than 6 million families could face foreclosure over the next three years.
As a result of the continued foreclosure increase, the housing market has a surplus of available properties. The shape of this second downturn is almost completely dependent on the level of government intervention that will take place.
For a number of reasons, banks have not been aggressively taking title to homes and selling them, which has resulted in very few distressed sales in comparison to the actual level of distress in the market. This delay in REO sales, along with historically low mortgage rates and an $8,000 tax credit, has helped to stabilize the housing market - temporarily.
It is very clear that price stabilization is temporary unless something is done. Here are some facts to help project what housing will be like in 2010:
- 13.54% of the 44.7 million mortgages tracked by the Mortgage Bankers Association are delinquent.
- 7.57 million homeowners are delinquent, applying the same percentage to the 11.2 million mortgages not tracked by the MBA (55.9 million total mortgages in the U.S.). That means that 10% of all homeowners in the country are delinquent.
- Based on historical trend analysis by Amherst Securities, 6.94 million homes that are already delinquent will be liquidated, which is more than a one year supply of distressed sales poised to hit the market sometime in 2010 and 2011. During Q1 2005, that figure was only 1.27 million.
- Defaults continue to grow at the rate of approximately 300,000 per month, assuring that the number of distressed sales will grow and will continue through 2012.
2009 Government Intervention
Government intervention to date has been extremely helpful in preventing an even more dramatic decline in home prices. As shown in the chart at right, housing demand has only fallen to "normal" levels and stabilized there. Without historically low mortgage rates, support for Freddie Mac, Fannie Mae and FHA, and an $8,000 tax credit, how far would sales have fallen this year and what would that decline in demand have done to pricing?
Conclusion
Demand needs to continue to be stimulated to bring down supply, particularly while the country continues to lose jobs. Without continued government intervention, home prices will plummet, banks and the GSEs will continue to lose money, and the economy has virtually no chance of increasing overall employment in 2010.
Property Owners Given the Opportunity to Challenge Their TRIM Notices Online
According to Ken Burke, Clerk of the Circuit Court for Pinellas County, as of Monday, August 31, 2009 property owners who disagree with their property value assessments can file petitions to go before the Value Adjustment Board (VAB) online via the Clerk’s website www.mypinellasclerk.org. Along with the online petitioning feature, the Clerk’s website will now offer petitioners the ability to submit any supporting documents online.
Property owners who disagree with their assessments are given the opportunity to meet with the property appraiser’s office to further discuss their notices. If the outcome of this meeting is still to the dissatisfaction of the owners then they may file a formal challenge with the VAB.
The Value Adjustment Board acts as the decision-making authority between the property owners and the property appraiser when a disagreement arises over exemptions, valuations and classifications. Once this petition has been filed, a quasi-judicial hearing is scheduled with a special magistrate.
Previous methods of petitioning to go before the VAB are still available however the forms can now be easily accessed online and then mailed or filed in person at the Clerk’s Board of Records department. The forms can also be dropped off at any one of the following three Clerk branch offices: the St. Petersburg Branch at 545 First Ave. N., St. Petersburg; the Tyrone Branch at 1800 66th St. N., St. Petersburg or the North County Branch at 29582 U.S. 19, Clearwater.
On Monday, August 24, 2009 the property Appraiser’s office mailed the Truth In Millage (TRIM) notices, giving property owners until Friday, September 18, 2009 to file a petition challenging their property tax notice.
The TRIM notice will include the homeowner’s property taxes, property assessments and proposed millage rates set by the various taxing entities. According to Pam Dubov, Property Appraiser the market values shown on the 2009 TRIM Notices are based on the current market conditions and ownership status of the property as of January 1, 2009 which is determined by analyzing sales that took place in 2008.
Bankruptcy Court Finds Discharge of Indebtedness by Issuance of 1099-C Forms Does Not Equate to Discharge of Debt
By: Brett Henson
For homeowners considering a short sale or deed in lieu of foreclosure ("DIL") as a means to prevent foreclosure, a recent bankruptcy decision from the Third Circuit has important implications towards the treatment of deficiency liability. In re Zilka, a July 2009 case from Pennsylvania, the debtor received a post-petition personal injury settlement allowing for settlement of all creditors claims in the bankruptcy estate. At issue was whether a creditor could file a claim against the debtor for accounts it had previously charged off and issued 1099-C forms for cancellation of debt to the IRS. The debtor argued the charged off accounts and the 1099-C forms amounted to a discharge of the debts. However, the court distinguished between a charge off of indebtedness and a discharge of indebtedness. The court found the IRS requirement that a lender file a 1099-C form to be a reporting requirement for income tax purposes. In contrast, it held state law governs whether a discharge of debt has occurred. As such, a creditor may still attempt to collect on a charged off debt during bankruptcy proceedings, even if it has previously issued 1099-C forms.
The ruling in Zilka highlights the importance of tax considerations for homeowners who complete a short sale or DIL. Banks must issue a 1099-C anytime there is a deficiency resulting from the sale of a property. For instance, a homeowner, Bill, owns two properties: property 1 is his primary residence and property 2 is an investment property he rents to tenants. For the purposes of the example, Bill considers property 2 a bad investment because the mortgage balance is $45,000.00 greater than the value of the property, and he is unable to find tenants. He obtains a short sale offer of $20,000.00 less than the value of the property, which the bank is willing to accept. Should the sale close, the IRS requires the bank to report a deficiency of $65,000.00 (Mortgage balance of $45,000.00 + $20,000.00 less the value of the property) to by filing a 1099-C form. When Bill completes yearly tax returns, he would be required to report the $65,000.00 as gross income, which, after deductions and exemptions, would increase his taxable income, and potentially place him in a higher tax bracket. The ruling in Zilka, though, would allow for Bill to re-adjust his income if the bank later filed a claim in bankruptcy court for the deficiency of $65,000.00. In short, Zilka affirms the principal that a debtor may be liable for deficiencies by either an increase in the debtor's taxable income or the creditor's right to collect on the deficiency, but not both.
There are a few applicable exemptions under the Internal Revenue Code for tax liability resulting from deficiencies in debt settlement. For instance, deficiencies resulting from the sale of a qualified principle residence are exempt from gross taxable income in most circumstances. In the example above, the QPR exemption would apply if Bill can show he has lived in the property for 2 years, the debt was used to acquire, construct, or substantially improve the property, and the total debt is less than $2 million. Although this exemption excludes deficiency income reported through a 1099-C from Bill's gross income, it also increases his tax basis if there is a short sale of the property. However, the insolvency exemption, which applies if Bill's total liabilities exceed his assets, would operate to cancel any liability resulting from this increased basis.
A Guide to Federal & State Restraints on Consumer Debt Collection
By: Paul Silvestri
Many of us are often victimized by unscrupulous businesses attempting to collect debt using intimidating guerilla tactics. Few really know the different consumer protection statutes which exist to protect the public from these unethical and sometimes even threatening business practices. 15 U.S.C. §1692, et sequi known as The Fair Debt Collection Practices Act (“FDCPA”) is the federal law which promotes ethical business practices by debt collectors. The Florida counterpart is Fla. Stat. §559.55, et sequi, more commonly known as The Florida Consumer Collection Practices Act, (FCCPA). These acts establish general standards of prohibited conduct, define and restrict abusive collection acts, and provide specific rights for consumers.
As a result of the rise of information technology, debt collectors have become increasingly sophisticated and deceptive in their practices. Therefore, it is necessary for consumer’s to know their rights.
Validation Rights Concerning Debt
General Notification: Within 5 days after the initial communication from the consumer in connection with the collection of any debt, a debt collector shall, unless the following information contained in the initial communication or the consumer has paid the debt, send the consumer written notice containing – 1) the amount of debt; 2) the name of the creditor to whom the debt is owed; 3) a statement that the consumer has 30 days to contest the validity of the debt and if they fail to do so the debt will be assumed to be valid; 4) A statement that after the consumer contests the validity, the debt collector must produce verification of the debt or a copy of the judgment against the consumer to be delivered to the consumer.
Request for Validation: If consumer disputes the debt within the 30 day window, the collector shall cease collection of the debt until the debt collector verifies the debt to the consumer and provides the name and address of the original creditor.
Representations Concerning Amount of Debt
The FDCPA is violated when any communication is sent to the consumer which does not completely disclose the full amount of the debt. 15 U.S.C. §1692g. Even a statements such as “this amount does not include accrued but unpaid interest, or unpaid late charges” has been held in violation.
False Threats of Lawsuits
The FDCPA contains a general proscription against the use of any false, deceptive or misleading representation or means in connection with the collection of nay debt. 15 U.S.C. §1692e. The misrepresentation or exaggeration of the imminence of a suit on intent or authority to sue constitutes a violation of the FDCPA.
Communication With Third Parties
A debt Collector, with limited exceptions or to effectuate post-judgment judicial remedy, may not communicate in connection with the collection of any consumer debt, with any person other than the consumer, his attorney, a consumer reporting agency, a creditor, the attorney of the creditor, or the attorney of the debt collector.
