Short Sales, Deficiencies, Deficiency Judgment, Taxes…WHAT??

As a realtor or an investor you must have a handle on how to explain to home owners what their facing when it comes to tax liabilities and deficiencies. First off, “I’m not a CPA or tax attorney.” These are the first words that come out of my mouth followed by “please obtain legal council or contact a CPA to provide greater detail.”

Now with that said we do have a responsibility to know what the hell we are talking about so I decided to post an email I sent to my JV realtor partners to give some insight and reference material when discussing this topic. Enjoy

If a 1099 is issued, then the lender is saying you, the homeowner, is relieved of the debt and it’s taxable income. If a bank pursues a deficiency then the homeowner is not relieved of the debt thus it can’t be taxed. Once again, it’s one or the other. A homeowner will not get a 1099 for the forgiven debt, if the deficiency is pursued by the lender since no debt has been forgiven. Now for some explanation of the terms involved.

Deficiencies

When a homeowner buys a house they sign two documents.
A promissory note – This is a personal guarantee to pay the lender the amount borrowed.
A mortgage or trust deed – The lien against the real property, and secures the promissory note.

The Deficiency (Not Deficiency judgment) is the difference between the amount owed and the short sale approved sale amount. A deficiency by itself is unsecured and is governed by state law statute of limitations.

The Deficiency Judgment is the end result of a court case. Meaning the homeowner has been sued (foreclosure) and has lost. A judge then has to rule and issue the judgment, hence “Deficiency Judgment” This is good for 20 years!

Why someone would want to avoid foreclosure is as follows:

The seller will still have a deficiency of whatever they owed versus how much the bank sells the property for. In addition, they will be responsible for all attorney cost, HOA fees, taxes, and insurance the bank pays until they can liquidate the property through a sheriff sale or as an REO. If the property doesn’t sell at the sheriff auction it can take up to 12 months to become and REO, in which the lender will issue for the deficiency and then file a civil suit for the total loss.

Tax Liabilities

If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income or they may insolvent.

Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets. All details covered here http://www.irs.gov/pub/irs-pdf/p4681.pdf

Example:

In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower’s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt.

Take Care,

Carl

As a realtor or an investor you must have a handle on how to explain to home owners what their facing when it comes to tax liabilities and deficiencies. First off, “I’m not a CPA or tax attorney.” These are the first words that come out of my mouth followed by “please obtain legal council or contact a CPA to provide greater detail.”

Now with that said we do have a responsibility to know what the hell we are talking about so I decided to post an email I sent to my JV realtor partners to give some insight and reference material when discussing this topic. Enjoy

If a 1099 is issued, then the lender is saying you, the homeowner, is relieved of the debt and it’s taxable income. If a bank pursues a deficiency then the homeowner is not relieved of the debt thus it can’t be taxed. Once again, it’s one or the other. A homeowner will not get a 1099 for the forgiven debt, if the deficiency is pursued by the lender since no debt has been forgiven. Now for some explanation of the terms involved.

Deficiencies

When a homeowner buys a house they sign two documents.
A promissory note – This is a personal guarantee to pay the lender the amount borrowed.
A mortgage or trust deed – The lien against the real property, and secures the promissory note.

The Deficiency (Not Deficiency judgment) is the difference between the amount owed and the short sale approved sale amount. A deficiency by itself is unsecured and is governed by state law statute of limitations.

The Deficiency Judgment is the end result of a court case. Meaning the homeowner has been sued (foreclosure) and has lost. A judge then has to rule and issue the judgment, hence “Deficiency Judgment” This is good for 20 years!

Why someone would want to avoid foreclosure is as follows:

The seller will still have a deficiency of whatever they owed versus how much the bank sells the property for. In addition, they will be responsible for all attorney cost, HOA fees, taxes, and insurance the bank pays until they can liquidate the property through a sheriff sale or as an REO. If the property doesn’t sell at the sheriff auction it can take up to 12 months to become and REO, in which the lender will issue for the deficiency and then file a civil suit for the total loss.

Tax Liabilities

If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income or they may insolvent.

Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets. All details covered here http://www.irs.gov/pub/irs-pdf/p4681.pdf

Example:

In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower’s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt.

Take Care,

Carl