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Short Sale and Foreclosure Questions and Answers

Q. SHOULD I WORK OUT A SETTLEMENT WITH MY CREDIT CARD COMPANIES INSTEAD OF FILING BANKRUPTCY?
 
A. Here is how it works. The forgiveness of debt is considered to be income by the
Internal Revenue Service. For example, if you have a credit card to which you owe
$10,000.00. That credit card company approaches you and is willing to accept
$3,000.00 and write off the rest if you can pay them. You in turn consider this to be a great deal and you find $3,000.00 dollars to pay off this $10,000.00 credit card. At the end of the year you will get a 1099 from that credit card company for that $7,000.00. That is the amount of forgiven debt. Unfortunately the credit card company has no choice and must issue a form 1099 to you. You will owe tax to the IRS at whatever your normal tax rate is on that $7,000.00 just as if it were cash income that you received.  An exception to this rule exists if you are able to demonstrate insolvency to the IRS under its own procedures.
 
Assuming that you can not demonstrate insolvency to the IRS, this actually puts you in a worse position than you were in before you settled the debt with the credit card company. Because the tax owed is now so recent from the transaction you will not be able to immediately file a bankruptcy to discharge your obligation to the federal government. Should you have chosen to file bankruptcy on the credit card debt instead of settling it you could ordinarily have discharged the entire amount with no tax to you. This is because a discharge in bankruptcy is not a taxable event. The law does not require the creditor to issue a form 1099 to you for the discharge of that $10,000.00 credit card debt in bankruptcy. You will owe no tax on the transaction.
 
Q. SHOULD I SHORT SELL MY HOME?

A. The same general rule as to the taxability of forgiveness of a credit card debt applies also to mortgages that are forgiven.
 
When a lender/bank elects to sell your home, a “deficiency balance” is usually created.  The “deficiency balance” is that amount of the unpaid loan remaining once the foreclosure sale proceeds have been applied to your loan balance. This is the amount of the sales proceeds after the bank has already deducted the costs of sale. This deficiency balance can be substantial in today’s real estate market. Deficiency balances of $100,000 - $150,000 are common. Except under limited exceptions in California the bank may sue you for this deficiency, then attach your wages or levy bank accounts.

Regarding short sales, in California recent legislation Senate (Bill 458) was passed indicating that if a bank consents in writing to a short sale of a dwelling after July 15, 2011 that it may not pursue you for the remaining deficiency balance (i.e. it must forgive you of the excess debt over and above the sales price as long as the bank gets all of the money). However, if there is a first and a second it would appear that you need to secure the written consent of the second as well to claim this protection. If either the first or second do not agree to release their lien, then a short sale probably will not occur. However, if it does, you may continue to be liable to the lender that does not consent in writing to the transaction.

For short sales of non-dwellings and other real estate in California, dwellings of more than 4 units in California, and short sales of homes in many other states there still remains two types of short sales. In the first type of short sale, the bank simply states that it will release its interest in the property to the buyer of the property. However, they retain their rights to pursue you for any deficiency balance. Until recently those were the types of short sales that were generally accomplished. The second type of short sale is one where they will agree to release you of any deficiency balance after the short sale. Many people and even their real estate agents believe that they are doing a good thing if they can secure a forgiveness of the deficiency on a mortgage by participating in a short sale transaction with the bank. 

In reality, the forgiveness of a deficiency balance can create a worse problem for you than what you would have had if you would have simply let the bank foreclose on your home. Just like the credit card company, the deficiency balance owed would ordinarily be discharged in the bankruptcy. However, the tax obligation that is created by the forgiveness of debt will not be discharged in a chapter 7 bankruptcy filed any time in the following 3-4 years. Even the tax on a forgiven deficiency balance from a mortgage can be disabling.  

Q. DIDN'T THE MORTGAGE DEBT RELIEF ACT OF 2007 MAKE IT SO THAT I
DON'T OWE TAX ON ANY FORGIVENESS OF MY MORTGAGE DEBT?
 
A. Sometime in December of 2007 the President signed the Mortgage Debt Relief
Act in an attempt to address this concern. Generally, the Act states that if a bank does choose to forgive you of a deficiency balance on your home, then the forgiveness of that deficiency will not be considered income to you.
 
Unfortunately, this general rule is filled with many exceptions and exclusions.
Among those exclusions are:
 
1. The home involved has to be your principal residence. If it is a rental property the
    Mortgage Debt Relief Act gives you no relief.
 
2. You must have lived in the house for at least two years.
 
3. The debt involved cannot exceed your basis in the home.
    For example, you paid $250.000.00 for a home in 2001. In 2005 when the market
    was strong you refinanced you home and pulled out $100,000.00 of equity and
    put it into another house, investment or spent it. Now you owe $350,000 on a
    home that you only paid $250,000 for.  Even if the bank choose to forgive your
    debt and you lived in the home for two years you may still be subject to taxation
    on that other $100.000.00 of forgiven debt that represented the money you took
    out of the home.

Q. DID THE $700,000,000,000 BAIL OUT FOR THE FINANCIAL INDUSTRY AFFORD SPECIAL POWERS TO THE BANKRUPTCY COURT TO REDUCE OR “CRAM DOWN" MY HOME LOAN TO AN AMOUNT EQUAL TO THE CURRENT VALUE OF MY HOME?

A. No. The "Cram down" provisions of the bankruptcy law do not apply to your
home mortgage. It has been this way since 1978. Nothing was in the final version of the September 2008 legislation to change that.
 
The above analysis is not intended to be an extensive analysis reciting all of  the exceptions to the Mortgage Relief Act. There is not enough room to provide an
extensive legal analysis of the areas of law touched on herein. Your situation may differ drastically from the examples that we have provided. This has been provided for informational purposes only, and is not intended to be relied upon without a consultation with a qualified attorney regarding you specific situation. However, whether you should do a short sale or proceed in some other fashion is a very complicated question that you must look into thoroughly before you make the decision. If you make the wrong decision you could be saddled with a very difficult situation that will follow you for a number of years.

Q.  WHAT HAPPENS TO THE HOMEOWNERS' ASSOCIATION DUES ON MY PROPRTY WHEN IT STAYS IN MY NAME BECAUSE THE BANK HASN'T COMPLETED ITS FORECLOSURE ?
 
A. There is a point of law which can present a difficulty for those who own or owned real estate which is part of a homeowners’ association.  As you are aware, unless you reaffirmed your mortgage(s)/deeds of trust in the bankruptcy, they have been discharged.  If the mortgage has been discharged, there is no potential liability.However, when there is a homeowners’ association, the legislature has carved out a specific exclusion when the property continues to be held in your name after bankruptcy filing.  You continued to be liable for homeowners’ association monthly dues assessed post filing so long as the property remains in your name.  Now this may present a problem if you were waiting for the lender to complete a foreclosure when the lender is slow to move. The homeowners’ association has three options.  Number one, they can file a lien against the property and hope to be paid.  Or, secondly, they can accept a deed from you transferring the property into their name.  A third option is for them to sue you.  The first two options are usually not likely in the situation where there is no equity in the property.  The third option is the most likely for those HOAs that are well advised of their rights.What does this mean for you?  Let’s say for example the homeowners’ association dues for the property you plan on surrendering in your bankruptcy are $200 a month, and at the time of filing your bankruptcy you have $5,000 in association dues outstanding.  Your bankruptcy is filed.  Your mortgage lender takes a full 12 months to complete the foreclosure of the property.  The association dues of $200 a month have been accruing for the past twelve months, meaning the HOA could pursue and obtain a judgment against you for the $2,400 following the successful discharge of your bankruptcy.  This would represent the homeowners’ association dues accruing post filing while the property remained in your name.  On the other hand, the $5,000 in homeowners’ association dues owed at time of filing would be discharged and could not be pursued by the HOA.So then you may ask “what can I do?”  I believe there are four options. 

Option one is to pursue a deed in lieu of foreclosure with the lender.  One problem is that it can be time consuming and the lender need not accept the deed.  In the meantime, while you’re waiting for the lender to decide, the HOA dues continue to accrue in your name.  The other problem with this approach is that the lender may be unlikely to accept the deed in lieu when there is a junior lien holder such as a second mortgage or any other type of junior lien because by accepting the deed in lieu they will have to pay the junior lien holder out of the proceeds from the eventual sale of the home.

Option two is to attempt a short sale of the home and request the homeowners’ association to file a lien against the property so that it gets paid during the course of the short sale.  If they do not, you would insist that as part of the sale transaction, the HOA dues get paid through the close of escrow.
Option three is to live in the property and pay the homeowners’ association fees until there is a foreclosure.Option four would be to rent the property out, if the HOA restrictions permit it, and use the rental income to pay past due and current HOA fees.  You have the complete legal right to rent the property so long as it remains titled in your name.  In addition, I would highly recommend disclosing in the rental contract that the property is in foreclosure and that the rental proceeds are being used to pay the HOA dues.  Furthermore, you should not agree to any longer a term than a month to month lease.  This should help to avoid any claims of wrongdoing or fraud against you by any opportunistic tenants.  If you pursue this option, the property needs to have been in your name for at least one year.Please keep in mind, in order to elect option four it is important that the deed of trust did not have an Assignment of Rents attached.  If it did and you do not use the rent to pay the lender, you could be liable in the future for those amounts received.  If this is your situation, call us because some planning may be appropriate for you.  I would like to emphasize thought that if the home was financed as a principal residence it is very unusual to have an Assignment of Rents on the Deed of Trust. As you can see this area of law if fraught with pitfalls and I would like to extend our continued availability to you in order to assist you in resolving this issue if you are dealing with it. 
 
 
 
Lien Stripping

Q.  CAN I GET RID OF THE SECOND OR THIRD MORTGAGE ON MY PERSONAL RESIDENCE THROUGH BANKRUPTCY?
 
A.  The answer to this question in the 9th District Court of Appeals (Which includes California) is, Yes, under the right circumstances. Case law has come down over the last couple of years in this district that allows for this. 

Q.  HOW DOES IT WORK?

A.   On personal bankruptcy this process may not be done through a Chapter 7 fresh start bankruptcy. Rather it is limited to the reorganization types of Bankruptcy such as a Chapter 13 or Chapter 11 where some effort is being made to pay a portion of your unsecured debt back over the term of a plan where payments are being made through the Court. (For example payments over 36-60 months). Normally, upon successful completion of the plan then receive your discharge of the remaining balances.

During the bankruptcy you must file a lawsuit within the bankruptcy (Adversary
Proceeding) against the mortgages that you would like to strip off of your home.
In order to win that lawsuit against the mortgage holder, among other things, you
need to prove that the current market value of the home is less than or equal to
the amount that is owed against the first trust deed (or first mortgage). If you are
able to prove your case then the second and/or third trust deeds/mortgage will
be stripped off of your home and treated like a credit card. They end up receiving
a percentage of their loan with the credit cards from the payments that you are
making into the plan. The amount of those payments have no relation to the
amount that your original payments were to them under the loan agreement. At
the successful completion of the plan they are discharged with the remaining
credit card balances and you keep your home free and clear of the second
and/or third.

Q.  IS THIS AS GOOD AS IT SOUNDS ?
 
A. It can be. However, it involves a commitment. First, it involves a reorganization type of bankruptcy which is generally more expensive than a fresh start. Secondly, it involves a lawsuit. This also adds more expense. As part of that reorganization you are agreeing with the Court to make
monthly payments to the Court as part of the plan. That is something else that
you do not do in an fresh start Chapter 7 bankruptcy. Finally, you also agree that
you are going to keep the payment on your first mortgage/trust deed current during the term of the plan.
 
These two requirements prove to be the most daunting for most individuals.
Failure to do these things can and usually will mean dismissal of your plan. So,
even if you have successfully sued and completed your lawsuit against the
second and/or third trust deed/mortgage holders and you are well into your plan,
you can still loose all of that effort and investment by dismissal of the case if you
fail to continue to meet the obligations of the plan at any time during that 3-5
year period. When that happens the second and/or third trust deeds/mortgages
stay attached to your home and survive the bankruptcy that was dismissed.
 
It is very important that you carefully consider the cost and commitment of
attempting to strip the second and/or third from your home before you attempt it.
However, if it is something that you can complete, in most cases you can save a
lot of money.

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