Short Sale Legal Considerations – Jan 2014
Terry Jessop & Bitner Newsletter
Issue 5, January 2014
Home prices and sales are increasing. The amount of time it takes to foreclose just doubled. Short sales can do what all creditors want – recoup as much money as quickly as possible! A short sale is an alternative to foreclosure and occurs when an owner sells his or her property for less than the amount of debt encumbering the property. For example, Mr. Doe may owe $150,000 to a bank on a primary mortgage, $35,000 to a credit union on a second, $14,000 on a HELOC, and $1,000 to a judgment creditor. If Mr. Doe sells his house for anything less than $200,000, the sale proceeds will fall short of paying all of the debt.
Creditors Hold the Cards, but Be Careful
In every short sale scenario, one or more creditors may take less but permission is required of all. This creates interesting challenges. If Mr. Doe wants to sell his house for $150,000, his bank in the scenario above will want all the proceeds. The credit union would then receive nothing, and will have no incentive to approve the short sale. A creditor who stands to gain the most from a short sale might be tempted to hide or manipulate information, hoping to get the approval of creditors that have less to gain. A creditor who stands to gain little may be tempted to accept kickbacks or cash on the side from a real estate agent or the buyer in exchange for permission. Creditors need to avoid temptations that require hiding information from other affected creditors, as this may lead to a violation of RESPA and/or constitute short sale fraud. Creditors may want to get a title report before considering a short sale so they are familiar with all liens on the property.
No More Tax Relief for Mortgage Forgiveness
In Utah and most other states, a creditor who accepts a short sale can still sue the borrower for the deficiency. While a creditor may forgive the debt, the Mortgage Debt Forgiveness Relief Act made it so that from 2007 to 2013, many borrowers did not have to pay tax on forgiven deficiencies. That Act expired at the end of 2013. (But be on the lookout because a few politicians have already submitted bills proposing to extend the Act.) So for now, if Mr. Doe’s credit union forgives $10,000 Mr. Doe may have to pay tax on that income. Federal law requires Mr. Doe’s credit union to submit a form 1099 C to the IRS notifying it of the forgiven debt. See 26 USC § 6050P. Knowing this, some borrowers may be more likely to pay extra cash or sign a promissory note for some or all of the deficiency remaining after a short sale. Creditors should keep this in mind when negotiating a short sale.
The Dreaded Statute of Limitations
A creditor wanting to recover a deficiency after a short sale must act quickly. Utah Code § 78B-2-313 allows only three months following a short sale to file a deficiency action. But if, prior to the closing of the short sale, Mr. Doe’s credit union obtains a written agreement where Mr. Doe agrees to pay some or all of the deficiency, the credit union will have six years to file an action to recover the deficiency. ( See § 78B-2-309.) This is because the lawsuit would not be based on the short sale deficiency statute, but rather on the breach of the agreement Mr. Doe signed.
Show Me the Money
Creditors usually won’t approve a short sale unless the money they receive exceeds their recovery from foreclosure. Creativity when negotiating a short sale becomes key. Mr. Doe’s credit union may want to see if the bank is willing to hand over some of its recovery. Maybe Mr. Doe has some cash lying around or a real estate agent willing to part with some of her commission. Keep everything above the table and in front of the other creditors. If you have questions or need help, give us a call.
©Terry Jessop & Bitner January 2014