Deficiency Judgements and Tax Implications

The good news is that California offers some protections for consumers against deficiency judgments after short sales and foreclosures. A homeowner is generally protected against a deficiency judgment after short sale for a one-to-four residential unit property. The instances in which a homeowner is generally protected against a deficiency judgment following foreclosure include, among other things, a non-judicial foreclosure or a loan that is all of the following: 1) owner occupied, 2) secured by a one-to-four unit dwelling and 3) purchase money. Homeowners are also protected against deficiency judgments after foreclosure of seller financing.

Sellers may be responsible for taxes on, among other things, cancellation of debt (COD) income, which is approximately the difference between the outstanding loan balance and the fair market value. The exceptions to being taxed on COD income include bankruptcy, insolvency and forgiveness of a nonrecourse debt after foreclosure.

Nonrecourse debt in California is when a loan is made to purchase a one-to-four unit, owner-occupied property or when the seller carries back financing. In the case of a short sale or foreclosure, the Mortgage Forgiveness Debt Relief Act of 2007 also provides an exception from federal taxation when the following conditions are met: 1) property must be a qualified principal residence as defined, 2) loan is secured by the residence, 3) income relief is capped at $1,000,000 for married couples filing separately and $2,000,000 for all others, and 4) loan is discharged after January 1, 2007 and before January 1, 2013. Additional rules apply under California law.

Credit Consequences and Timing

Credit may be adversely affected regardless of the type of sale—foreclosure or short sale. Credit score declines can vary and the negative mark may remain on the credit report

for seven years. Both foreclosures and short sales might affect the ability to quality for a loan to purchase another home. In some short sale cases where the seller may have even been current with mortgage payments but sold the home for less than the outstanding loan amount, the credit report could indicate that the debt was settled for less than what was owed and the impact may be less severe.

In the event of a foreclosure, a borrower may not be able to qualify for another home loan for seven years without any extenuating circumstances, or five years with extenuating circumstances, under current Fannie Mae guidelines. The wait may be less with short sales. If payments are in arrears in a short sale, buyers may qualify to purchase another home within about two years for a Fannie Mae backed mortgage, or approximately three years for a FHA loan. If payments were current, consumers may qualify for another loan immediately, but it can be difficult to find a lender.

Exceptions and additional considerations apply to the conditions discussed, depending on individual circumstances. For consumers facing these difficult choices,
it is advisable to seek professional assistance from an attorney and/or an accountant who can evaluate your specific situation.

This information is believed accurate as of February 2, 2012. It is intended to provide general answers to general questions and is not intended as a substitute for individual legal advice. Advice in specific situations may differ depending upon a wide variety of factors. Therefore, readers with specific legal questions should seek the advice of an attorney.

Two thousand eleven was a challenging year. As we put the numerous trials and tribulations behind us, it’s important to look at the opportunities in the year ahead. While the housing market is not without its share of difficulties, there are some bright spots.

Foreclosures:

The inventory of bank-owned properties is expected to increase in 2012, according to RealtyTrac®, and California will continue to be a hotspot for foreclosures. While notices of default and lender repossessed properties both declined in November 2011, a leading indicator points to a potential jump in the inventory of distressed properties: scheduled foreclosure auctions. There was a 63 percent month over month increase in scheduled foreclosure auctions in California in November 2011, the highest state rate in the nation. This poses tremendous prospects for investors to cash in on those properties at desirable prices. It would also be a good opportunity for qualified buyers who have been sitting on the sidelines awaiting the right opportunity; the expected bump in inventory and continued low mortgage interest rates make for ideal buying conditions. With the economic recovery picking up some traction, interest rates are likely to rise in the coming years and these ideal buying conditions will not last forever.

Some Pros & Cons of Investing in Real Estate While being an investor has its benefits, it is not without its challenges, so it’s important to do your research and be prepared to face the obstacles. The benefits of owning property include the steady income from rents, tax deductions, appreciation of property value in the long run and the pride of ownership. With currently low inflation rates, the potential for equity gains in real property is greater because home values will rise as inflation rises.

On the other hand, short term market volatility, maintenance expenses, vacancy, the occasional bad tenant, exposure to liability and finding qualified professionals to assist with providing necessary services are eminent risks. For investment property owners, it is not a matter of whether you will have to deal with these nuisances, but when. To remedy that, there are steps you can take to prepare for that rainy day.

The best solution is to maintain a healthy liquid asset account. Cash is ideal, but short term or monthly money market or certificate of deposit accounts are also good options. Depending on the type of property, its condition, the mortgage and other monthly expenses, it is recommended to have at least six months of expenses in liquid savings or about 10 percent of the property’s value, especially if major repairs are anticipated. Good planning and organization is essential to maintaining and keeping track of expenditures and all property matters, particularly in preparation for filing taxes. This preparation will also enable owners to determine the appropriate amount of insurance coverage to purchase. Being educated about your investments is likewise crucial to protecting your assets, hence due diligence in assessing your risk cannot be emphasized enough.