Tuesday, October 19, 2010

Short Sale

Deficiency Balance




September 30, 2010 was a big day for anyone in California short selling property. On that day, Governor Schwarzenegger signed into law SB 931, will take effect on January 1, 2011 and will be codified in the California Code of Civil Procedure Section 580e, what we commonly refer to as the “anti-deficiency” statutes. This is an important win for upside-down owners.  For the last few years, the question has been: what is the deficiency liability following a short sale. This statute answers it in part.

Beginning January 1, 2011, any first trust deed lender who approves a short sale of a residential real property, will be prohibited by law from collecting the unpaid loan deficiency after the sale.

OLD LAW: A short sale occurs when the net proceeds from the sale of real property are less than the balance owed on the loans secured by the property.  In a short sale, unless the lender provides a specific written waiver of the unpaid balance of the loan, the lender has the legal right to pursue the borrower for the deficiency.

NEW LAW: On September 30, 2010, Governor Schwarzenegger signed Senate Bill 931into law, which amends the Code of Civil Procedure to add a new section 580e.  This statute applies to first trust deeds secured by one to four unit residential properties that are sold by short sale.  Under the new law, when the first lender approves a short sale of residential property containing one to four units, such approval will automatically act as a waiver of the lender’s right to collect the loan deficiency.  The first deed lender is then barred by law from pursuing a deficiency judgment against the borrower (seller).
There are exceptions.  If the borrower has committed fraud against the lender or waste against the property, the statutory protection is lost, and the lender may sue the borrower for the deficiency plus damages.

The new 580e states in part: “No judgment shall be rendered for any deficiency under a note secured by a first deed of trust or first mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for less than the remaining amount of the indebtedness due at the time of sale with the written consent of the holder of the first deed of trust or first mortgage. Written consent of the holder of the first deed of trust or first mortgage to that sale shall obligate that holder to accept the sale proceeds as full payment and to fully discharge the remaining amount of the indebtedness on the first deed of trust or first mortgage.”

ANALYSIS: This statute provides a significant new protection to homeowners who sell their residential property by short sale.  Prior to the enactment of §580e, short sellers had no statutory protection from deficiency judgments.  This meant that a homeowner could sell a property by short sale and then be sued by the lender for the remaining balance owed on the loan, even though the property had already been sold.
Thanks to this new law, beginning January 1, 2011, the short seller of a one- to four-unit residential property will automatically be protected against a deficiency judgment from the first position lender under CCP §580e.  This means that a homeowner who sells their property by short sale cannot be sued by the first position lender after the sale.  This protection applies whether the property was the seller’s primary residence, a rental property, or a vacation home, so long as it has fewer than five units.  The property need not be owner-occupied for the protection to apply.
However, because CCP §580e only applies to first position lenders, junior lenders continue to have the right to pursue a deficiency judgment against a short seller after the sale.  To be protected from potential deficiency judgments pursued by any junior lenders, the short seller must, at the time of the short sale, obtain the junior lenders’ written waiver of the junior lender’s right to pursue a deficiency.
It is also important to remember the statute is not effective until January 1, 2011.  It is unlikely to be given retroactive effect.  Therefore do not rely upon its protection for short sales that close escrow during the remainder of 2010.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are upside-down on your loan(s), and considering a short sale, get competent legal advise in your State immediately so that you can determine your best options

The Mortgage Forgiveness Debt Relief Act and Debt


If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. Also see IRS news release IR-2008-17.

The following are the most commonly asked questions and answers about The Mortgage Forgiveness Debt Relief Act and debt cancellation:

What is Cancellation of Debt?
If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.

Is Cancellation of Debt income always taxable?

Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:



The short sale process is still a mystery to many people. Buyer's agents are confused; puzzled buyers are looking for direction, and not every short sale listing agent knows how to do a short sale.

Banks grant short sales for 2 reasons: the seller has a hardship, and the seller owes more on the mortgage than the home is worth.
A few examples of a hardship are:
● Unemployment / reduced income
● Divorce
● Medical emergency
● Job transfer out of town
● Bankruptcy
● Death

The seller will need to prepare a financial package for submission to the bank. Each bank has its own guidelines but the basic procedure is similar from bank to bank.

The seller's short sale package:

● Letter of authorization, which lets the listing agent speak to the bank.
● HUD-1 or preliminary net sheet
● Completed financial statement
● Seller's hardship letter
● 2 years of tax returns
● 2 years of W-2s
● Recent payroll stubs
● Last 2 months of bank statements
● Comparative market analysis or list of recent comparable sales

Banks are not in the business of giving away a home at rock-bottom pricing. The bank will want to receive somewhat close to market value. The short sale list price may have little bearing on market value and may, in fact, be priced below the comparable sales to encourage multiple offers. After the seller accepts the offer, the listing agent will send the following items to the bank:

● Listing agreement
● Executed purchase offer
● Buyer's preapproval letter and copy of earnest money check
● Proof of funds to close
● Seller's short sale package

If the package is incomplete, the short sale process will be delayed. In this event, the bank might even shred the package.

Approximate time line

● Bank acknowledges receipt of the file. This can take 10 days to a month.
● A negotiator is assigned. This can take 30 to 60 days.
● An appraisal is ordered. The bank probably will refuse to share the
   results of the appraisal.
● A second negotiator may be assigned. This can take another 30 days.
● The file is sent for review or to the investor. This can take 2 weeks to 30 days.
● The bank may then request that all parties sign an Arm's-Length Affidavit.
● The bank issues a short sale approval letter.

Some short sales get approval in 6 to 8 weeks. Others take 90 to 120 days, on average.

For more information, please visit my website: www.sandytroia.com
You can also email me at: sandy@sandytroia.com

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

More information, including detailed examples can be found in

  • Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
  •  Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
  • 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.
  • Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
  • Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
                                          These exceptions are discussed in detail in Publication 4681.

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