URGENT – IRS and FTB Update Regarding Short Sales

in , , , , , , , , , , , , , , , , , , , , , , , /by

The California Association of Realtors yesterday issued a press release stating that, as a result of recent rulings by the Internal Revenue Service and California Franchise Tax Board, mortgage debt forgiven in a California short sale is no longer taxable as income.

This is huge news, since the tax exemption for this income tax was scheduled to expire on December 31, 2013 when the Mortgage Debt Relief Act expired.  Without these rulings from IRS and FTB, California homeowners whose short sales did not close by year end were facing potentially enormous tax liability.

The IRS ruling was contained in a letter to Senator Barbara Boxer.  The FTB ruling was in a letter obtained the C.A.R. from Board of Equalization member George Runner.

The rationale for the rulings appears to be that debt forgiven in a short sale is not considered “recourse” debt under California law, thus exempting it from taxation.

The C.A.R. press release does not state whether this ruling also will apply to short sale of non-primary residences in California, or if it is limited to only certain types of mortgage debt.  I have requested my tax experts to review the actual letters and updated regulations to clarify these issues; I will provide that response immediately upon receipt.

At this point, it appears that similar protections will be extended to homeowners whose properties are foreclosed after December 31, 2013 where the debt forgiven was used to buy, build, or make substantial improvements to a primary residence.  It does not appear these protections will apply to “deed in lieu” transactions.

California homeowners with pending short sales may breathe a sigh of relief.  For these folks, it would appear that Christmas came a few weeks early this year.

SB 458/931 Not Impacted by Debt Forgiveness Relief Act Expiration

in , , , , , , , , , , , , , /by

No New News of Possible Extension of Mortgage Debt Relief Act

I continue to receive daily inquiries from homeowners and real estate professionals regarding the pending December 31st expiration of the Mortgage Debt Relief Act.  Unfortunately, the matter remains mired in the highly politicized negotiations over the “fiscal cliff.”  While I remain hopeful that the necessary parties will set aside their differences for the benefit of distressed homeowners, that hope is tempered by skepticism based on the lack of progress in the negotiations.

Meanwhile, I urge all affected individuals to contact their congressional and senate representatives to let them know where you stand.  And keep your fingers (and toes) crossed.

My purpose is writing this blog is to address a separate but related issue about which I’ve also received numerous questions.  Specifically, are California’s SB 458/931 threatened by the potential expiration of the Act?  The short answer is “no.”

Don’t Confuse California’s Short Sale “Anti-Deficiency” Protections with the Taxability of Forgiven Debt

California Senate Bills 458 and 931 were enacted in 2011 and are now found in Section 580e of the Code of Civil Procedure.  These laws say that a lender who agrees to a short sale is barred from collecting any portion of the mortgage debt not paid from the proceeds of sale.  In other words, the “deficiency” is deemed “forgiven” as a matter of law; thus the term “anti-deficiency” protection.

Before Section 580e, lenders frequently approved short sales only on the condition that the seller/borrower agreed to repay some portion of the loan deficiency.  This is no longer allowed.  More importantly, there is no “expiration date” to this California statute.  It will remain in effect unless and until repealed by the legislature with the consent of the governor.  That is extremely unlikely.

In summary, no matter what happens with the Mortgage Debt Relief Act, mortgage holders whose lenders approve a short sale of their California property will remain protected by the state’s “anti-deficiency” statutes; they will not have to repay any portion of the unpaid, forgiven loan balance.

Impact of Expiration of Act on California Short Sales

In contrast, expiration of the Mortgage Debt Relief Act will remove many of the protections that qualified homeowners have had since 2007 for the tax consequences of forgiven mortgage debt.  In other words, the IRS will tax as income any portion of the home loan not repaid to the lenders from the proceeds of the short sale.  (As stated in earlier articles, there are other possible tax exemptions applicable to this “income”; however, far fewer property owners will qualify for these other protections.)

Expiration of the federal Act will trigger expiration of California’s related tax protection.  That is, the law passed in California to protect homeowners from the state income tax liability for forgiven debt also expires on December 31, 2012.

There is no guarantee that an extension of the federal exemption will automatically result in an extension of the California exemption.  For that reason, it is also important to contact your representatives in Sacramento to urge extending the state tax protection.

If you are uncertain regarding the impact of these matters on your situation, please contact qualified legal and tax professionals without delay.


 

Important HAFA Program Changes Announced

in , , , , , , , /by

The federal government’s flagship HAFA short sale program continues to evolve in hopes of more effectively addressing the needs of distressed homeowners for whom continued ownership is not longer a realistic option.  The most recent Supplemental Directive 12-02 was released on March 9, 2012; loan servicers are instructed to implement program changes effective immediately.  They include:

  • There are no longer any occupancy requirements for HAFA eligibility.
    Previously, HAFA required that the property be occupied as the borrower’s primary residence at some point within the prior 12 months.
  • The amount a servicer may authorize the settlement agent to pay from gross proceeds to subordinate mortgage holder(s) in exchange for a lien release and full release of borrower liability is increased from $6,000 to $8,500.
  • Borrower relocation incentives will be limited to HAFA short sales or Deed-in-Lieu transactions where the property is occupied by a borrower or a tenant at the time of the Short Sale Agreement or DIL Agreement and who will be required to vacate the property as a condition of the sale or DIL.
  • Borrowers may now elect to remain current on the loan during the term of the Short Sale Agreement or DIL Agreement.
  • Credit bureau reporting of HAFA transactions are amended as follows:
    • If the real estate is sold for less than the full balance owed and the deficiency balance is forgiven, report the following Base Segment fields as specified:  Account Status Code = 13 (Paid or closed account/zero balance) or 65 (Account paid in full/a foreclosure was started), as applicable.
  • The deadline for HAFA has been extended. A borrower now has until December 31, 2013 to submit a Short Sale Agreement or a written request for a consideration for a Short Sale Agreement to be eligible for HAFA.

The stated intention of the program updates is to expand the availability of HAFA’s benefits to more struggling homeowners.  Certainly, the increase in the amount of gross proceeds available to settle junior liens should help.  This has been an area of particular concern, most especially in California where the implementation in 2011 of SB 457 barred
lien holders from reserving collection rights following short sales or, alternatively, from conditioning short sale approval from additional seller contributions.  Of course, as with all previous program changes, the proof will be in the pudding.  Stay tuned….

Playing the Simon card in short sale negotiations

in , , , , , , , , , /by

As a real estate professional negotiating short sales on behalf of underwater property owners, your chances of success are directly tied to the laws that apply to your client’s situation.  In other words, if a lender won’t approve your client’s short sale, what leverage do you have to “push back” and change that decision?

We start by analyzing the client’s foreclosure rights.  That is, what will happen if the short sale doesn’t get approved and the client instead lets the lender foreclose? California has “anti-deficiency” laws that lay out exactly what happens when a lender forecloses.  In most cases, the answer depends on the type of loan (or loans) involved.

A loan that is used to buy a borrower’s primary residence is considered a “non-recourse” loan.  If a lender forecloses on such a non-recourse loan, all it gets is the property.  The law bars the lender from collecting the balance still owing, commonly called the “deficiency.”  (There are some rare exceptions to this rule, typically involving income or commercial properties; those are not addressed here.)

If the borrower took out a second loan as part of the original purchase money financing, that loan is also considered “non-recourse.”  If the first mortgage (known as the “senior lien holder”) forecloses its loan, the second lender (the “junior”) is barred from collecting its deficiency.

In contrast, if the second mortgage was not purchase money but instead was added later (often as a home equity loan or “HELOC”), the loan is considered a “recourse” loan.  In that situation a foreclosure by the senior lien holder usually does not bar the junior lender from collecting its deficiency.  However, there is a very important exception to this law.   That exception is known as the Simon rule (named for a 1992 case called Simon vs. Bank of America).

The Simon rule comes into play where senior and junior liens were issued by the same lender; e.g., Bank of America first and Bank of America second.  In that case, the law bars the junior from collecting its deficiency if the senior forecloses.  The rationale is that the senior has the ability to protect its own junior loan; and where the senior decides not to do so, Simon says that it gives up its right to collect the deficiency on the junior.

If your client has a Simon loan situation, you now have much stronger leverage in negotiating a short sale.  If the lender denies the short sale, you simply advise that your client will let the property go to foreclosure.  In that case, the lender will get zero on its second loan.  And in most situations, lenders would rather get something for their junior lien than nothing.

With the recent changes in California short sale laws – in particular the new SB 458 – many realtors I’ve talked to are afraid that second loans won’t approve short sales.  For that reason, it’s more important than ever to know what exactly cards you can play on your client’s behalf when seeking that approval.  In some cases, the Simon card may just be your “ace in the hole.”

If you suspect you may have a potential Simon situation, first locate copies of the deeds of trust for both the senior and junior liens.  Then give me a call and I’ll help your clients and you analyze those documents to determine if in fact Simon applies.

Finally, I’d like to thank Kim McAtee of Coldwell Banker’s Orinda, California office for suggesting the blog topic.  I always welcome readers’ suggestions on topics they’d like to see.  Thanks, Kim!

SB 458 Fills Hole in Homeowners’ Short Sale Protection

in , , , , /by

On July 11, 2011, Governor Jerry Brown signed Senate Bill 458.  Effective immediately, the new law provides critical protection to homeowners pursuing short sales of their underwater properties.

A little background: On January 1, 2011, California’s anti-deficiency laws (contained in Section 580 of the Code of Civil Procedure) were amended to include limited protection to borrowers following a short sale.  Prior to that time, the only anti-deficiency protections available to borrowers occurred following a foreclosure of the loan by the senior lien holder.  By adding subsection “e” to Section 580, Senate Bill 931 enacted a bar against senior lien holders pursuing collection of a loan deficiency following that lender’s consent to a short sale.  Unfortunately, no similar protection was enacted for borrowers with junior liens on their properties.

The problem developed that these junior lien holders were aggressively pursuing collection of loan balances despite agreeing to short sales negotiated by the borrower and the senior lien holder.  The end result was that many borrowers were opting for foreclosure in an attempt to obtain protection under the foreclosure anti-deficiency statutes.  This trend compounded the foreclosure crisis and further drove down property values.  For that reason, and on an expedited basis, the California Association of Realtors sponsored SB 458 specifically to bar collection by junior lien holders who consented to short sales.  That is the legislation that Governor Brown signed on July 11th.

SB 458 is unusual in that it contains an “urgency provision.”  In most situations, there is a lag between the time a governor signs a bill and when it becomes effective.  But SB 458 (which revises the new Code of Civil Procedure Section 580e) by its terms is effective immediately, a clear recognition by the legislature and the governor of the serious nature of the problem created by the junior lien holders’ hard-nosed collection actions.  SB 458 will apply to any short sale that closes escrow on or after July 11, 2011.  (In other words, we look to the date escrow closes, rather than the date of the lender’s approval.)

The law also specifically makes “void and against public policy” any attempt by a junior lien holder to force a borrower to waive the protections of the new law as a condition of a short sale approval.  In other words, even though a borrower may sign a waiver in a short sale approval letter, if escrow closes after July 11, 2011 the lender may not enforce the waiver.

In addition, effective immediately a lender cannot require a borrower to pay any additional compensation in exchange for a short sale approval; however, the new law does not prohibit a borrower from voluntarily offering a monetary contribution to a lender in hopes of obtaining a short sale.  A lender is also permitted under the new law to negotiate for a contribution from someone other than the borrower, such as other lenders, agents, relatives, and the like.

A significant question exists whether junior lien holders will now simply refuse to approve short sales and instead force borrowers into foreclosure, further exacerbating the housing crisis.  A similar concern was raised following the enactment of SB 931; however, that concern has proved largely unfounded.  In short, we will have to wait and see.

If you or a client has questions regarding the applicability of the new legislation to a particular transaction, please contact me and I will be happy to consult with you and/or the client regarding this issue.