All of us have seen the good work done by Zovall and OCRenter on mortgage fraud. There is even a website called Paladin Reports being set up to track and report mortgage fraud. If someone wants to profit from all the short-sale activity which will be common in the market in the near future, you could track and report these sales to the IRS. IRS pays informants to squeal on tax cheats. A short sale is a taxable event because the borrower no longer has to pay back a liability they once had. In the eyes of the IRS, this is income subject to taxation. This makes sense when you think about it. If someone loans you $100,000 and you don’t pay it back, you made $100,000. It is either a gift or income both of which are taxable. How many people who short-sell in the upcoming collapse are going to report this income? I would estimate none.
If you report a tax cheat to the IRS, they will give you 15% of what they collect. Plus you get the satisfaction of knowing you kicked some poor FB while they were down. What could be better? When you think about the dollars involved, even 15% of the taxes collected could amount to millions of dollars. If a typical short sale is $50,000 (a guess), and the FB’s tax rate is 25%, that is $12,500 in taxes. 15% of $12,500 is $1,875. If you made an average $1,875 on each short sale, you could make $93,750 for tracking 50 short sales. That is more than the median income in Irvine. Track 500 short sales, and you could make almost a million dollars. How much work would that be?
For information on how report tax cheats, see IRS publication 733. Anybody want to take this project on?
oc_fliptrack - you are correct. BUT, the IRS does not get a 1099’s is when the buyer bought the home at inflated price and 100% financing, and the buyer recieved illegal cash back from the seller, which is unaccounted for, which technically is an income for the buyer. Here is the problem, the poor buyer would owe the IRS "double" tax!!!!!!!! if some report. The IRS is a big winner!!!!
Question: I understand that a "short sale" means the mortgage lender agrees to accept as payment in full a sale for a home’s market value even if it is below the mortgage balance. That’s what we did to sell our house in Ohio. It was worth less than our mortgage balance, and we had to move for work reasons. The lender agreed to accept a short sale for $183,785 though our mortgage balance was $210,000. But we received IRS Form 1099 from the lender showing we had taxable "debt-relief" income of $26,215. How can we be taxed on money we didn’t receive?
Answer: As an alternative to foreclosure when a mortgage borrower stops making payments, some lenders will accept a "short sale" of the property for less than the mortgage balance. The lenders realize it is better for them to accept a short sale than to go through a foreclosure sale and lose even more money.
However, the IRS says debt relief is taxable. That’s why your mortgage lender had to send you that 1099 form showing the exact amount of your taxable debt relief.
Very interesting read. So how would you acquire one of these homes after a short sale to the lender? I’m "assuming" that they will relist the property for a later time?
-bix
I have been investigating the IRS liability for short sale forebearance. I have a question, though, for anyone who may have the answer.
Background: Purchase Money Loans are the initial loans used to purchase property, and will show up on the Title Chain as the First Trust Deed at the time of purchase. These loans have additional protections in them that other loans do not. For instance, in the case of a foreclosure, the lender is not permitted to collect any additional money from the borrower, even in the case of a "short sale", usually handled in through a Judicial Foreclosure with a deficiency judgement. However, as soon as a borrower refinances the loan, ALL of these protections are removed. (of course, this is NEVER disclosed on a loan refinance contracts, even though it absolutely should).
Question: It looks like the lenders are avoiding the costs of a Judicial foreclosure (which gets expensive), thus forfeiting their right to a Deficiency Judgement (collection for the amount lost in the short sale) and opting instead to simply write it off as a loss, and inform the IRS of the "debt forgiveness". QUESTION: CAN THE LENDER ISSUE A 1099 FOR PURCHASE MONEY LOANS? To me, this would seem to be a clever way of getting around the protections that exist in the Purchase Money Loan, and not terribly fair. However, no one has ever accused the IRS of being fair.
Note: If this trend of housing doom continues, the short sale deficiencies are going to grow exponentially - which will almost certainly mean that a FLOOD of bankruptcies are going to follow. People are simpy not going to be able to pay one third of the deficiency amounts.
By the way, kudos to IrvineRenter. You gave me an EXCELLENT numerical basis upon which to get an understanding of what is going on. I do still believe that people will always be willing to pay a slight premium for ownership over renting, but it certainly gives the best "jump in" and "jump out" point for the real estate market that I have seen. Nothing else really makes sense.
Final questions: A) Are the banks actively renting out their REO’s.
B) Do you think that the banks are going to pay property taxes on their REO’s, or take advantage of the 5 year delay allowed by the IRS before a Tax Sale. (by my estimation, CountryWide alone has 1,400 REO’s in California at a mean value of $500,000, which works out to $700 Million in total property values, or $7 million annual for property taxes on their REOs. If this housing crash is going to take as long as many people think, the banks will pretty much have no choice but to pay that taxes.
You raise some interesting questions related to short sales and a lender’s options on foreclosure. This whole area of law is a bit confusing. For instance, piggy back loans in the second position are usually a total loss in a foreclosure. Sometimes the lender in the second position will opt to go through a judicial foreclosure to secure its interest if the lender thinks the FB has any assets left to go after. A lot of people think they have the option of a short sale, but if they have any assets, the banks generally won’t let them. Only the poorest of FB’s with no other assets will generally be given a short sale. Even after a short sale, some lenders may not issue a 1099 because they may not want to write off the debt. Some short sales are going to have side agreements where the seller gives the lender an unsecured note. And even if they issue a 1099 and write it off, this debt can be sold to a zombie debt collector who may still go after it.
As for your questions, banks generally do not keep or rent out their REO’s. They just don’t like to be in the property management business. They have to pay the property taxes for the period of time they own the properties. When they go to convey title at the final disposition, all taxes will have to be current.
Thanks Irvine Renter!
I agree that banks traditionally are not in the property management business. However, you must agree that there is nothing standard about this situation. If the crisis deepens and their REO inventory rises exponentially, they may have to consider it. Or are you suggesting at that point that they would simply opt to lower the prices until they sell. At this point I think they are holding on to their REO inventory hoping that many will move in Spring and Summer. We will probably have to wait until winter to see what they will do. I have only begun checking REOs recently since properties have been too highly priced for me to even consider buying a home… but I would imagine that their inventory is reaching record levels. (I spent 12 years in Asia, so I missed the 90’s bubble.)
Final question for Irvine Renter: I checked your calculations for the Income to Selling Price Ratio. Am I correct in assuming that your .666667 was an adjustment of income for taxes, and your .45 represents the standard income allocation to property ownership expenses?
Thanks again for you comments!
NickStone and anyone else interested - California is a non-recourse loan state. What that means is if the owner goes through foreclosure or short sale and the loans were the original purchase loans all the lender can go after is the house. They will not be personally liable for the difference in the loss. If the property was changed to a "rental" then the former owner could actually deduct the loss on his/her taxes. That is what makes these fraud deals we keep seeing so interesting. In some cases a refinance loan will fall under the category of non-recourse if there was no cash paid or the cash was used for repairs or improvements. I think this is a real grey area so I am not 100% sure how it would work. As for other refinance loans where there is cash out to go buy a boat then the lender can go after them personally/legally for the difference.
As for taxes the lender most likely will send a 1099 to the IRS and the former owner which would be taxed at their income tax rate. The loop hole in this is if the deadbeat is insolvent at the time of the foreclosure or short sale debt forgiveness may be excluded from their gross income. Again when it comes to these fraud properties we find with the name changes it makes it even more interesting.
As for the lenders holding the REOs is more because they don’t currently have the staff to handle the surge in properties they now own. Like you have seen with Countrywide. I think they own a quarter of Sacramento. As much as the lenders are hoping for a hot spring selling season they may add heavily to the inventory problem if they get staffed up in time.
If lenders don’t already have their own REO departments, they can outsource to title companies (for instance, Fidelity) who may have been named as the Trustee when the DOT was recorded; attorneys; property management companies that specialize in marketing REO properties.
With regards to deducting the loss on his/her taxes, I believe the tax rule is if (s)he "personally" manages the property, i.e. setting the rental price, selecting the prospective renters, etc, (s)he can deduct the loss. This rule also applies if one hires a professional so long as (s)he retains the power to set the rental price, selecting the prospective renters, etc. There are other limitations, too: maximum $25,000 loss allowed, and then even less if the income exceeds $100,000 per year (I think!). Consult your tax experts.
Your observations on my calculation assumptions is exactly correct. They might be off one way or the other, but the net is pretty close to reality—at least the reality of how much people are willing to put toward home ownership here. IMO, 45% of income is too much to put toward housing. I put about 25% of my income toward a really nice rental to compensate my wife for not owning .
It is my understanding that lenders who gave out piggy-back loans do have recourse if they go through a judicial foreclosure, but they give up any recourse if they don’t. I have been told they generally won’t bother because the judicial foreclosure is too expensive. Do you know if this is accurate?
When lenders foreclose on the deed of trust (sometimes referred to as the mortgage), they are basically looking to the collateral to satisfy the debt. Foreclosures are much quicker (usually within 4 months from the time of first missed payment) and are a non-judicial process. If the funds were used in a purchase money transaction, lenders cannot later pursue the borrowers for any deficiencies. This anti-deficiency rule does not apply to a refinance. Hence, lenders can opt to sue on the note to obtain a personal judgment against the borrower for any deficiencies if lenders determine that the borrower has other assets to satisfy the debt.
Deficiencies rarely are sought, but my guess is if the current "subprime" and "alt-A" woes are deeper than previously estimated, lenders may consider this option. Few people, however, realize that when they refinance, a lot of protection against your other assets is lost.
Thank you Irvine Renter for the confirmation!
Follow up question for Illirvine: I agree that lenders cannot go after borrowers for deficiencies on a purchase money only loan, even if it is for 100% financing. Can you confirm that this also means that they cannot 1099 them after the short sale for the deficiency? That would logically make sense, but I am not sure of the IRS rules on this.
Irvinerenter - You are correct the second loan even if it were used for the purchase it would be a recourse loan and the only way to recover would be through a judicial foreclosure. As far as I know that just doesn’t happen in CA.
NickStone - See my post above IIIrvine’s. The lender will most likely send a 1099.
Irvinerenter - I just read the AFB post and finally I get your idea about trying to make some money from the IRS. Since the lender didn’t send a 1099 to the former owner it would not matter to the IRS and he would still be liable for the taxes on the debt forgiveness. Just as if you were to receive income even without a 1099 you are supposed to claim that income on your taxes. Now I am interested.
NickStone - I am not a tax expert so I cannot confirm if the lenders will 1099 after a short sale, but my general understanding is that for any debt relief, there will be a 1099. Note that there are also credit implications if the short sale is due to an involuntary foreclosure, as opposed to a voluntary short sale where the borrower pays for the difference out of pocket.
It would be interesting to find out. Do lending laws that protect home owners under foreclosure for purchase money loans actually also have protections from the IRS. If they do not, then the law is flawed and does not achieve what it was designed to do…. namely prevent bankruptcy for those families undergoing foreclosure. It pretty much goes without saying that if a family stipped of all of their assets, liquidity and credit rating in a foreclosure will not be able to pay the IRS bill. This is why I am curious.
Question for Irvine Renter and / or Graphix (who seems to have gotten it). : In your initial point about "no 1099 being issued". What was your point exactly? I didn’t see the angle that you were going for, other than the buyer who seems to have avoided being taxed on the losses, even though there was a Second Trust Deed piggybacked on the FTD. Can you explain what you were getting at?
I actually started this post a bit tongue-in-cheek; however, there is a real opportunity to make money here. When banks don’t issue a 1099, it doesn’t mean the FB did not get debt relief; therefore, the FB does owe money to the IRS. Without the 1099, the IRS will not know they are owed money, so reporting these people is the only way the IRS would ever find out about the debt relief and taxes owed. None of these FB’s are going to report this income even though they are required to do so by law. Particularly if the had a short sale, they are not going through bankruptcy, and the are emerging relatively unscathed. Basically they are avoiding their responsibilities to both the lender and the IRS. That bothers me. Remember, the FB has not avoided taxation, they have only avoided being reported.
NickStone - There is no protection from the IRS. The only way that you would legally avoid the tax is if at the time of foreclosure or short sale you were insolvent. So if you were stripped of your assets, liquidity and credit you would not have to pay the tax.
The 1099 point is that the lender should send one to the IRS and the former owner. Even if they do not send a 1099 and they are not insolvent they are still liable for the tax. The IRS wants their money even if a form was not filed. I have done consulting work in the past and not all the companies sent me a 1099 for the income I received but to be safe I declared the income. Legally I was supposed to and if I didn’t and I got audited and the IRS found that income 1099 or not they would want their cut. So if someone goes through foreclosure and there is a loss for the lender they need to file that on their taxes regardless of whether or not they got a 1099. If you didn’t read the link Irvinerenter added http://www.housingbubblecasualty.com/ read how the guy didn’t get a 1099. Guess what? We could turn him in to the IRS and he would have to pay the tax and the IRS would pay us a reward for it. After all that babble I think that is what you were looking for. Am I right?
IrvineRenter,
My CPA said something similar to what you wrote. In the case of frauds where the buyer recieved income from the seller, this income is not taxable; however, this income lowers the cost basis of the home.
Yep. I now get it. One of the other threads actually showed the link for the IRS whistleblower form to turn these people in, and the rules surrounding it. The main one is that you have to give your name, which they keep confidential… which of course makes sense since the IRS would have no idea who to send the payment to in an anonymous situation.
I would imagine that it is only a matter of time before the idot Casey Serin on www.iamfacingforeclosure.com is turned in. He is responsible for a WHOLE BUNCH of violations, including taking too much money back on a purchase, misrepresentation of income, etc. On one of these sites the FBI actually posted a link to their website which showed "Misstatement of Income on a Signed Document is a Federal Crime." This will probably come out much more as the Alt-A loans fail, which of course is a bit silly, since stated income loans are basically called "liars loans", as you well know.
Wow, I think this might backfire on the IRS. But then again, I bet they are all for building a bigger empire. When this happens to me, I HUNT down a 1099 form so that I can keep it above board. I guess I’m just way too honest.
-bix
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