While little has been done at the State or Federal level to provide assistance to upside down homeowners, efforts have been made to give greater protection to tenants in foreclosed properties. 

As a general rule, a foreclosure wipes out all leases and other rental agreements leaving the tenant in a month-to-month situation. For tenants on a lease, this can be a great shock when a Notice to Quit is posted on the front door.  Typically, state law requires the new owner to give the tenant 30 Days to vacate and if they don’t do so an eviction action can be started.  In July, 2008, California has adopted Code of Civil Procedure Section 1161(b) granting all residential tenants or sub-tenants a 60 days written notice to vacate after foreclosure.

In addition, in May, 2009, President Obama signed the “Protecting Tenants at Foreclosure Act of 2009″. The Act establishes a ninety (90) day notice to vacate period and grants additional rights to tenants in foreclosed properties. The central purpose is to provide innocent tenants, whose landlords have lost properties to foreclosure, with additional time within which to secure alternative housing arrangements.

EVEN MORE SIGNIFICANT is a portion of the Act which provides that, in the case of foreclosure on any federally-related mortgage loan or on any residential real property in which a recipient of public housing assistance resides, the immediate successor in interest assumes such interest subject to: (1) the lease between the prior owner and the tenant, and (2) the housing assistance payments contract between the prior owner and the public housing agency for the occupied unit.  Definition of a “federally-related mortgage loan” include any loan that a) is made by a lender that is either regulated by or whose deposits or accounts are insured by any agency of the Federal Government; b)  is made in whole or in part, or is insured, guaranteed, supplemented, or assisted in any way by the Federal Government; or c) is intended to be sold by the originating lender to the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation (or its successors).  This is a very broad spectrum of loans.  A ”housing assistance payments contract” means such Programs as Section 8. 

A thorough statement as to the purpose, import and impact of the Act can be found in a recent Federal Register Notice from the Department of Housing and Urban Development (”HUD”) and in a summary of Senate Bill 896. [Source www.thomas.gov].

The Act is extremely broad and vague and has given rise to more questions than answers, it is abundantly clear that the rights of persons or entities purchasing tenant occupied properties purchased through foreclosure after May 20, 2009, will be significantly impacted.

  If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.

A lot of mis-information appears to be circulating on the web concerning how the debt forgiveness tax relief is applied. “Debt Forgiveness” occurs anytime you don’t have to pay back a debt that you owe someone. In today’s world, that most commonly occurs through a foreclosure or a short sale when a lender or lenders are not paid in full. Unless the lender is pursuing a judgment for the deficiency (which is rare), our IRS Code states that the amount not paid, ie: forgiven, is taxable income to the borrower.  In December, 2007, the Federal government passed the Mortgage Forgiveness Debt Relief Act which provided that if you incur debt forgiveness between 2007 and 2012 on your principal residence there will be no tax. Some States have adopted similar provisions to deal with state taxes.  What has become confusing is what is meant by “principal residence”.

Several writers on the web have stated that the test for Principal Residence is that you lived in the property for 2 of the last 5 years. If this were true, then the forgiveness might be available even if the property is now rented out.  So, this is significant.  The “2 out of 5 years” rule is the test for capital gains tax exclusion and is used to determine whether you would have to pay capital gains tax when the property was sold or foreclosed. But this is a different question from debt forgiveness. Capital gains measures the difference between what you paid for the property (taxable basis) and what it sold for (short sale or foreclosure sale). So, if someone has owned their property a long time and refinanced well above their taxable basis, then the “sale” price could result in a capital gain tax to which the 2 out of 5 year rule would apply.  Ambiguities in explanations of the Mortgage Forgiveness Debt Relief Act have led some to conclude that the determination is made by using the capital gains rule on personal residence.  I do not believe that this is accurate. More importantly, this mis-information could leave debtors exposed to debt forgiveness tax.

When it comes to tax questions, it is valuable to examine what the IRS has to say on the issue because if they disagree with what you claim, you’re in for a nasty and costly fight. Luckily, the IRS appears to have answered this question.

IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonment” is available for download at http://www.irs.gov/pub/irs-pdf/p4681.pdf. In this Report, the IRS explains how this is treated. At Chapter 1 “Cancelled Debts”, Page 7, the IRS defines what constitutes “Qualified Principal Residence Indebtedness” which is the criteria to avoid the debt. It clearly defines this as “the home where you ordinarily live most of the time. You can have only one principal residence at any one time”. There is nothing whatsoever that provides for a 2 of 5 year definition.

Based upon this, it seems conclusive to me that the IRS will only grant debt forgiveness on the home where you ordinarily live at the time that the debt forgiveness occurs.  Of course, reasonable people could reach different conclusions.  If you are facing a debt forgiveness event, be certain to get competent legal and tax advice.