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SB 30 Still Mired in Legislative Limbo

Hard to believe it’s now been more than 6 months since Senator Ron Calderon introduced Senate Bill 30 on December 3, 2012.  The bill passed an important hurdle late last week following passage by the Senate (36-0), and has now been to the Assembly’s Revenue and Taxation Committee.

A  recent amendment to the bill has created significant controversy and resulted in loss of support from its initial sponsor and strongest supporter, the California Association of Realtors.

Specifically, the bill as currently drafted now requires the passage of a separate piece of legislation, Senate Bill 391, also passes: “This act shall become operative only if Senate Bill 391 of the 2013–14 Regular Session is enacted and takes effect.”

SB 391 would establish a $75 per document recording tax to fund an affordable housing trust fund.  C.A.R., according to a recent press release, is opposing SB 391 “because it unfairly adds to the cost of recording real estate documents.”

It remains to be seen whether the State Assembly will further amend SB 30, including, possibly, the removal of the SB 391 link.  Any differences between the Senate and Assembly versions will be resolved in a concurrence committee made up of members of each house. The Governor will have thirty days to sign or veto the bill.

Meanwhile, sellers of underwater properties, or owners facing foreclosure, remain uncertain whether, and to what extent, they may face state tax consequences related to the transfer of their homes.  Certainly, a prompt resolution of the legislative impasse would bring welcome and needed clarity to a currently muddied real estate market.

URGENT: Homeowners Tax Exemption Extended Through 2013

The 2007 Mortgage Debt Relief Act, which was scheduled to expire at midnight on December 31, 2012, has been extended for one year as a result of the “fiscal cliff” deal struck between Congress and the president.

The Senate included the extension as a part of the bill that passed at 2:00 a.m. on Tuesday morning.  After House Republicans failed to pass a separate bill modifying the Senate plan, that plan was presented for a full house vote late last night and passed 257-167.  President Obama has stated he will sign the bill.

EXTENDS TAX FORGIVENESS FOR MANY HOMEOWNERS WHO COMPLETE A SHORT SALE, FORECLOSURE, “DEED IN LIEU”  OR LOAN MODIFICATION IN 2013.

This is very important news for homeowners whose short sales and “deeds in lieu of foreclosure” had not been concluded by December 31st, and who were facing a substantial income tax bill if the exemption had expired and not been renewed.  It also will benefit many homeowners whose properties are foreclosed in 2013, as well as individuals who obtain a “principle reduction” loan modification on their home mortgages.

EXEMPTION DOES NOT COVER ALL FORGIVEN MORTGAGE DEBT

As I have previously explained, the tax exemption does not apply to all forgiven mortgage debt.  Specifically, the debt must have been on a primary home, and the debt must have been used to either buy the property, to pay off purchase debt, or to repair/renovate the home.  It does not apply to debt on second homes or income property, or on “cash out” refi debt.

STATUS OF CALIFORNIA’S SEPARATE TAX EXEMPTION NOT YET CLEAR

Keep in mind that the separate California tax exemption for mortgage debt relief also was scheduled to expire on December 31, 2012.  Whether that state exemption will be extended as a result of the federal extension is not yet known.  I will report further once that information becomes available.

I recommend you immediately contact your local representative if you feel the California tax exemption should also be extended.

CONSULT WITH A QUALIFIED ATTORNEY OR TAX ADVISER NOW TO DETERMINE IF YOU QUALIFY

For “underwater” homeowners that have been “sitting on the fence”, now is a good time to speak with a qualified real estate attorney or tax adviser to determine whether and to what extent you qualify for the extended tax exemption.  Keep in mind that it can take many months for a short sale, loan modification, “deed in lieu” or foreclosure to be completed.  For that reason, it’s important to get the process started as soon as possible.  That way you can implement your best strategy without having to worry about losing the tax exemption at the end of 2013.

 

“Simon Rule” Gutted by New Court Decision

The so-called “Simon Rule”, among the most potent weapons available to distressed homeowners in negotiating short sales, and protecting themselves from financial liability following foreclosure, has been significantly weakened as a result of a new California court of appeals decision.  That decision, Cadlerock Joint Venture, LP v. Lobel (2012) 203 Cal.App.4th 1531, will change the landscape to the detriment of many struggling California mortgage holders.

How Does This Impact Homeowners Considering a Short-Sale?

Cadlerock now requires a court to look at who owns the loans at the time of the foreclosure by the senior lienor.  If the senior lienor has assigned/sold its junior lien to a third party prior to the foreclosure, that third party will now be able to sue the homeowner for the full amount of the junior loan after the foreclosure.  To summarize, following Cadlerock, in most situations the homeowner will lose the home and also have to repay the balance of the non-purchase money second loan.  (The court left a small amount of “wiggle room” for cases where the senior lienor assigns/sells its junior lien after the foreclosure.  There, Simon will still apply.)

Simon Rule Background

As discussed in previous articles, for the last twenty years many Californians with non-purchase money second loans have been able to protect themselves from claims brought by certain “junior” lenders after a foreclosure by the “senior” lender.  This protection originated in a landmark case called Simon v. Bank of America (1992) 4 Cal.App.4th 1537.

The Simon decision created an exception to the old rule that applies where a homeowner has two separate loans on a single property, and where the first mortgage holder (aka the “senior lienor”) forecloses on the property.  Before Simon, the second loan (aka the “junior lienor”) could collect the balance still owing on that loan after the senior foreclosed (and so long as the second loan was not a “purchase money” loan; i.e., part of the loan “package” used to buy the house).  (“Purchase money” second loans were, and still are, barred from collection under a separate rule not discussed here.)

What Simon said was that where the first and second loans were issued by the same bank (in that case, Bank of America), the bank could not collect on its second loan after foreclosing on its first loan; thus, the “Simon Rule”.  An equally important part of the rule was that a bank could not avoid this restriction by “assigning”, or selling, its second loan to another bank or investor.  In other words, courts would look to who owned the loans when they were issued.  If the same bank issued the two loans, the “Simon Rule” would apply.

In recent years, Simon became an invaluable tool in negotiating short sales involving non-purchase money second loans.  (See my January 2012 blog post, Playing the Simon Card in Short Sale Negotiations.Cadlerock now renders that tool virtually useless.

All homeowners considering short sales should consult with competent legal counsel to determine the impact of Cadlerock on their situation.  Failure to do so may result in enormous financial consequences and long-term hardship.

Playing the Simon card in short sale negotiations

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!