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Sacramento Short Sales Mortgage Debt Relief IRS Letter
Sacramento sellers who expect to close on a short sale in 2014 have a very good reason to send flowers to Sen. Barbara Boxer and, while they’re at it, maybe C.A.R. as well. I received the best news this morning, which I can’t wait to share with everyone because it’s about mortgage debt relief. Taxation on mortgage debt relief has been on the tongue of every single short sale seller I have talked to who might have to close escrow next year.
In a nutshell, we have no worries about federal taxation on mortgage debt relief resulting from most closed short sales in California from here on out. Other states, they probably have cause for concern, but not California. What makes California so special apart from our sunny weather, smog-hidden mountains and polluted oceans, and let’s not forget Cal Worthington? We’ve got California Civil Code 580e, resulting from the passing several years ago of SB 458.
Under ordinary circumstances, the federal tax code says if a person has had debt canceled, the amount that was forgiven is subject to taxation. However, in 2007, the Mortgage Debt Forgiveness Act passed that says taxation on canceled debt does not apply to a short sale, subject to certain criteria. Every year, the mortgage debt relief protection has expired and every year the federal government has extended it. This year, it’s not yet been extended because our lovely legislators continue to wrap in the mortgage debt relief extension with other legislation that won’t get passed even if they lined up every legislator against the wall, blindfolded them and threatened to shoot them all at will.
This political game has caused short sale sellers in Sacramento extraordinary grief and stress. Many of my sellers have called to say they don’t know what they will do if we can’t close their short sale by December 31st, 2013, when the federal mortgage debt relief protection expires.
However, the argument brought forth to the I.R.S. by Sen. Barbara Boxer, with C.A.R.’s assistance, is that sellers are released from personal liability in a short sale under California Civil Code 580e, and that makes short sales non-recourse, so why should a seller be subject to federal taxation on top of it? The I.R.S. agreed and issued a letter that said California short sales protected by our California Civil Code 580e are not subject to federal taxation for mortgage debt relief. This is huge!
C.A.R. and Sen. Barbara Boxer are working on a similar letter from the state of California, which is expected to follow suit.
California Short Sale Taxes vs. Personal Liability
A reader from my homebuying website on About.com asked me this morning if he could stop paying on a promissory note after his short sale closed. His short sale agent negotiated, he said, two purchase-money loans in 2010, in which he ended up paying the second lender $5,000, plus he handed over an additional $10,000 promissory note to a credit union. I suspect that the credit union loan was not a purchase-money mortgage because credit unions were not in the business of financing 80 / 20 combo loans. I’m betting that second loan was a hard-money loan. But that’s neither here nor there. The main problem for this guy seems to be that he negotiated a discounted payoff and promised to repay part of it, which he hopes to undo.
This is a pretty good example of short sale confusion. Not only do some people hope that once a law changes or goes into effect that it’s retroactive and can reach back into the past to change agreements or somehow alter things that were legal to do into being against the law — which ain’t gonna happen — but personal liability is often confused with taxation issues. Whether in California a seller has personal liability for a loan after a short sale is a separate issue from whether a seller is liable to pay taxes on that forgiven debt. Mortgage debt relief and whether banks can legally pursue a seller for a deficiency are not the same thing. They are two different things.
But wait, you might say, does this mean a bank might try to collect the balance due on a short sale at the same time the government goes after a seller for taxes on that balance due? Yes, that’s exactly what I am saying. It’s a double whammy.
Fortunately, SB 458, passed in California in July of 2011, added Section E to the California Civil Code 580. It basically says that short of mortgage fraud, in which case it can still pursue, if a seller does a short sale on 1 to 4 units, the bank can’t pursue; can’t go after the seller. But that’s for short sales that closed after July of 2011. It doesn’t matter if the loan was hard money or purchase money, whether the property was owner occupied or a rental, whether the loan was in first, second or third position. Can’t go after the seller. This is a good reason to avoid foreclosure and try to do a short sale. Especially if a seller has a hard-money loan because, legal experts say, foreclosure proceedings do not offer any protection for the seller against a hard-money loan.
But can the seller be taxed on a short sale? On the federal side, for 2013, the mortgage debt relief law has been extended to January 1, 2014. The California law regarding short sale taxes for 2012 has expired. State legislators are working on an extension. This is the part where the law after extension the last time was made retroactive. It took California lawmakers almost a year to pass the extension last go around. We were sweating. But then they made it retroactive. Will they do it again this year? We sure hope so. But this is a classic example of why a seller in Sacramento should get legal and tax advice before doing a short sale. Don’t rely on your Sacramento short sale agent to dispense legal and tax advice because we are not allowed to do it.
Back From French Polynesia
While you are reading this blog, I will be going through the agony of US Customs at LAX, having landed back in the country from French Polynesia. I know there are people who say just pack those black pearls, Tahitian rum and Cuban cigars in your luggage and keep your trap shut, but I am not one of those people who listen to that stuff. I don’t believe in smuggling stuff when you can report it, pay the tiny little tax and be done with it. Not everything that is Duty Free means you don’t pay tax anyway. And, if a US Custom official finds unreported taxable crap in your luggage, they can take it away from you. Why anybody would try to sneak stuff through US Customs is beyond me.
Why break the law? Why cause more problems for yourself? Life is filled with enough problems all by their lonesome little problem-selves, we don’t need to create more of them for ourselves. It’s like sellers who try to find creative ways around the rules of a short sale. They don’t realize that when they try to do that, they are taking a chance that the lender will find out. If the lender finds out, the lender can take away their release of liability. Just rip that rug out from under their short sale noses. There is no reason to tamper with your release of personal liability. None.
SB 458 paved the way for banks to go after sellers who commit mortgage fraud in a short sale. If there is no mortgage fraud and everything is clean and above board, sellers get a clean break. No deficiency judgment and no liability. They get off scott-free and can walk away into the sunset or hop on Air Tahiti if they so please. But there could be consequences if a seller breaks the law.
But consequences are not the only reason not to break the law. Heck, we have the death penalty in California and it doesn’t stop murderers from killing other people. Consequences don’t mean much to some people. Unfortunately, neither does just doing the right thing. For example, nothing seems to stop the antics of a person like Lindsay Lohan. Oh, wait, I think I spot her in line, three people down from me. Oh, crap.
In case you’re wondering, you don’t pay tax on $800 of merchandise, per person. Two people equals $1,600 of tax-free items. Pearls are taxable even though they are hand-made, regardless of what you may read online elsewhere.
A Bank of America Short Sale Counter Offer
Before I talk about a Bank of America short sale counter offer, let’s address this Lady Gaga thing. I mention it only because if I received an engraved invitation, I would decline to attend an event to watch Lady Gaga in a bottle strip to her undies and get a tattoo. I would not go even if I was invited through a last-minute text message. Surely, there are better things to do, no? Like, take out the garbage before your house starts to stink or get a pedicure. But this Lady Gaga thing was a huge black-tie event attended by celebrities as a debut perfume launch. It hurts my eyes to even read about it.
But maybe that’s why I am a Sacramento short sale agent and not running around with the likes of Jason Wu, Paris Hilton or Lindsay Lohan. I have many more exciting things to do like talk to third-party vendors at Bank of America about counter offers. What is a Bank of America counter offer? Well, for starters, it is not exactly a counter offer, which confuses a lot of Sacramento sellers. I try not to use jargon when talking with my clients, but sometimes it slips out, and for that I am truly sorry. I am not sorry that I didn’t go to the Lady Gaga event.
A short sale counter offer is issued by Bank of America or a third-party vendor representing Bank of America through Equator. It is a formal response to all of the fees noted on the HUD and submitted to Equator by this Sacramento short sale agent. See, if the bank can reduce some of the fees, that will increase the bottom-line net to the bank. Plus, investor guidelines state acceptable and non-acceptable fees. Some of the fees often contested are miscellaneous title services such as doc prep, courier, notary and some don’t want to authorize payment for recording of the deed. Sometimes they reduce the escrow fee.
In Sacramento, it is customary for the seller to pay the escrow fee. But in other parts of the country and California, the escrow fee is often split 50 / 50 between seller and buyer. It is not unusual for the bank to place a maximum cap on the amount it will authorize. In many instances, that amount is $750.
There are also negotiators at the bank who do not read the net sheets we send them. They instead read the HUD, and the HUD is very confusing to many people. Ever since the RESPA change a few years ago, we’ve been fighting battles with bank negotiators who insist that credits to the buyer are not allowed — when the credits shown on the HUD are not really a credit to the buyer at all. Sound confusing? Imagine how the bank negotiators feel.
Yesterday I spotted a city transfer tax fee of almost $600 that the negotiator had removed from the HUD. When fees are removed, it means the buyer has to pay them. Because of SB 458, the seller cannot pay fees the bank refuses to authorize. So, I questioned the negotiator. I asked her why it was removed because it was a standard and customary fee paid by the seller in Sacramento. This fee is based on .275% of 1% of the sales price. It can amount to a lot of money, in this case: six hundred bucks.
Turns out the negotiator thought it was a buyer credit on the HUD. After I explained that there were no credits at all on the HUD, the negotiator put that number back into the list of authorized fees and approved it. I wonder if she would like a bottle of Lady Gaga’s new perfume?
Photo: used with permission bigstockphoto
