California law requires that property owners must return the tenant’s security within three weeks from the time the tenant vacates and document any deductions. When ownership is transferred to another, the former owner is required to either transfer the deposits to the new owner or return them to the tenant.  But what happens when the property is foreclosed and the former owner that collected the security deposits is gone or even bankrupt?

Under California Civil Code Section 1950.5, a successor owner is jointly liable with the former owner to retun the deposits once the tenant vacates. The idea is that the innocent tenant’s right to the deposit should be protected and that any disputes over this are between the current and prior owner, not then tenant.  There is an ambiguity being argued by lenders that this obligation is extinguished by the foreclosure just as is the rental agreement itself.  This may be held to be true where the post-foreclosure owner treats the rental agreement as extinguished. In that case, the tenant similarly has no obligation to pay the rent and so the situation may become a wash.  But the result is reasonably different where the new owner treats the rental agreement as continuing and actually collects rent.  There, most likely, the law will protect the tenant.

Despite the above-stated ambiguity, all perties acquiring property through a foreclosure must anticipate that they will likely be liable for the tenat’s security deposit that was collected by the former owner. Further, they should make sure that they have a new rentail agreement signed by the tenant if the rental is to continue.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at stevebeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Many people are confused as to what happens if the property in which they live has been foreclosed. Most fear that a Sheriff will come knocking on the door to suddenly kick them out. In California (an likely most other states) that cannot legally occur.  A foreclosure simply creates a change in the ownership of the property. The rights of the occupants in the property are determined by what their status was before the foreclosure and now, Federal and California has made these rights even clearer.  This creates more protection for tenants and a possible trap for unaware foreclosure buyers.

Here are the current rules:

1. FORMER OWNER IS OCCUPANT - If the former owner remains as an occupant of the property after a foreclosure, the new owner must give that person only a 3 DAY NOTICE TO QUIT. The theory is that the former owner knew the foreclosure was coming so they should have made arrangements to move.

2. OCCUPANT IS RELATED TO FORMER OWNER - If the occupant is related to the former owner, ie: child, parent, or spouse, and the former owner is not an occupant, then the new owner must give the occupants a 60 DAY NOTICE TO QUIT. In theory related parties should be aware of what is going on. Even so, this change gives these parties more time than they had before.

3.  UNRELATED OCCUPANTS ON PERIODIC TENANCY - If the occupant is not a former owner or related to the former owner and is on a periodic tenancy such as month-to-month (not a Lease), then the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that periodic tenants are innocent victims who may be surprised by the foreclosure and will need more time to find a new place to live.

4.  UNRELATED OCCUPANTS ON LEASES -  If the occupant is not a former owner or related to the former owner and is on a fixed-term Lease (such as 6 months, one year, etc.), then the new owner cannot terminate the occupant’s tenancy UNTIL THE END OF THE LEASE TERM unless the new owner intends to occupy the property themseves in which time the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that while Lease tenants are innocent victims who may be surprised by the foreclosure, they contracted for a specific term and had no right to expect a longer tenancy. However, as set forth below, they may have to actually pay rent to get the benefit. Despite this however, since the foreclosure extinguished the Lease, the new owner can treat this resulting tenancy as a periodic month-to-month tenancy if they intend to move-in.

Much of the new requirements arise under President Obama’s “Protecting Tenants at Foreclosure Act of 2009’’ which was contained in the ‘‘Helping Families Save Their Homes Act of 2009’’, which was signed into law by the President on May 20, 2009. California amended its laws effective January 1, 2010 in compliance. While any new law becomes a fertile ground for disputes, this one presents an interesting issue concerning tenants on leases seeking to stay the duration of the lease. The Act defines a “bone fide lease” as being a lease which requires the receipt of rent that is not substantially less than fair market rent for the property. But does this mean that the rent must be paid? That remains unclear. If so, this would seem punitive considering that a tenant without a lease would get a 90 day notice with no obligation to pay. But is it really fair to the new owner to let someone live their longer than 90 days without paying? Perhaps the intent was only to establish that the lease was real…not to provide an ability for the new owner to collect the rent. But with no payment, who would ever want to bid at a foreclosure sale? Of course, it It will be up to the court’s to decide who’s interpretation is correct.

If you have specific questions about your loans, liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment. We offer a $200 flat fee attorney consultation to enable you to evaluate your judgment and tax risks and to plan a strategy to minimize or even avoid them. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage.

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.

The question keeps coming up:  What is the deficiency liability of an individual involved in a short sale?

In the current real estate market, short sales are becoming more prevalent as defaulting borrowers attempt to avoid a foreclosure on their property. The risk is whether a borrower after completing a short sale and receiving approval from the lender(s) would then become liable for any deficiency arising out of the difference between the principal amount owed on the mortgage(s) secured by the property and the amount the sale price agreed to during the short sale.

The short answer (in California at least) is that given the current statutory framework and case law available on this issue it is unclear whether there is any liability. California has three interconnected laws that govern lender recourse:  1) the Security First Rule; 2) the Single Action Rule; and 3) the Acquisition Loan Rule. These all limit the ability of a lender to go after a borrower for a deficiency following a foreclosure.  The language of each statute itself is broad enough that arguable they will preclude deficiency liability after a short sale (ie: the lender cannot simply waive the Security First Rule by releasing their security and then suing on the remaining debt).

Lenders have been scrambling to find a way around these Rules and create some recourse against borrowers following a voluntary short sale.  A short sale is a contract between the lender(s), seller/borrower, and buyer. In the contract, the lender is essentially agreeing to compromise their position in order to avoid a foreclosure. The lender is getting something of value in return for their agreement to the short sale. Likewise, the seller/borrower is getting something by way of release from deficiency debt. If the lender were to attempt to pursue a deficiency, against the borrower/seller then the contract likely fails for lack of consideration. Essentially, the borrower/seller in that situation got nothing of value for their participation in the short sale contract.  Whether less credit damage is consideration enough is very questionable.

Taking this to the last step in the analysis, brings us to the theory of accord and satisfaction. Which is a term of art that simply states that when one settles their rights for value and receives that value, then they have compromised their claim and can not pursue it any longer. By agreeing to contract for the short sale, the lender(s) is essentially stating that they are willing to take less in the short sale process to avoid the foreclosure process. Thereby precluding the lender from asserting additional claims for deficiency after the settlement process.

What has been happening with frequency lately, is that some lenders (such as BofA) are requiring borrowers/sellers to sign a document stating that the borrower will remain liable for the deficiency as a condition to the lender consenting to the short sale. The lender(s) are trying to contract around the anti-deficiency statutes prohibitions. While it is permissible for parties to contract around statutory obligations there is not any known reported case law on this particular issue where there is no real benefit to the seller/borrower… especially when it the contract increases the lender’s benefits. Certainly, it seems that by requiring the borrower/seller to sign such a document, there is a lack of consideration as discussed above. Thereby possibly nullifying the documents effect. However, there is no case law on this topic.

The bottom-line reality is if you are confronted with one of these documents, you should seek legal counsel regarding the terms of the particular agreement before executing the document, as you very well could be contracting away anti-deficiency protection and more than likely exposing yourself to costly litigation.

As readers of my Blog are aware, the Federal Government passed a law in December, 2007 allowing debtors to avoid the tax on debt forgiveness which typically occurs through a foreclosure or short sale. Debt forgiveness is considered taxable income by the IRS even though the debtor never had the actual income. The federal Debt Forgiveness Relief Act enables most people who lose their homes between 2007 through-going budget c 2012 to avoid the tax.  Most states including California followed suit although California’s relief expired in December, 2008.

In January 2009, Assemblyman Roger Niello introduced AB 111 to extend California’s law to match the Feds. Unfortunately, in late May the Assembly voted down his Bill… most likely in response to the ongoing Budget crisis. No new Bill appears to be in the works to replace this.  “AB 111 was based on fairness and common sense. The tax revenues from mortgage foreclosures are windfall gains to the state at the expense of California’s most desperate families. The tax revenue exempted by AB 111 would not have been realized if California weren’t at the very epicenter of the mortgage crisis,” said Assemblyman Niello.

If you are burdened by an over-encumbered property that you no longer can afford, be sure to get competent legal advice on your rights and strategies to minimalize or possible eliminate your exposure to a financial judgment and debt forgiveness taxes.  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/

As you know, a key point of President Obama’s Real Estate Recovery Plan unveiled last February was the proposal to allow Bankruptcy Court judges to reduced the principal balance on home mortgages (ie: cram-down”) to current market value.  To the cheers of upside-down homeowners and the jeers of the banking industry, the proposal was quickly brought up in the House of Representatives and was passed in mid-March with a close vote along party lines. Then it was off to the Senate where a vote was expected by Easter. It was not to be.

The banking industry found a much more receptive ear in the Senate.  The Bill’s sponsor, Sen. Richard Durbin (D-IL) fought hard for passage arguing that this was necessary to avoid a wave of future foreclosures. The banking industry countered that allowing the courts to interfere with a mortgage contract would create greater risk in the economy, deter investors, make loans harder to get, and ultimately hurt future homeowners.  The bankers bolstered their lobbying with 12,450 letters to Senators from its members and flooding their inboxed with e-mails.  In the end, pressure swayed enough moderate Democrats to join with the Republicans and defeat the Bill 51-45.  Sentator Durbin plans to continue advocating a cram-down bill in the Senate but for now it is dead. Meanwhile, the hundreds of thousands of foreclosures that have been holding off for this Bill will now likely go forward.

If you are burdened by an over-encumbered property that you no longer can afford, be sure to get competent legal advice on your rights and strategies to minimalize or possible eliminate your exposure to a financial judgment and debt forgiveness taxes.  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/

Most people are aware of the risk of lenders coming after them for a deficiency judgment after a foreclosure and they know how this may be avoided.  But few people understand or appreciate the tax liability that also can occur with any unpaid loan. But there also are times that this is avoidable.

Under our Federal Tax Law, anytime you owe money to someone else and then don’t have to pay it, “debt forgiveness” occurs (unless the lender gifts the debt to you which is not likely). The IRS says if you owed it, you must have had the money to pay it. So, if you got to keep that money, it must be income that they can tax you on.  That’s right, even if you never had this “phantom income”, it is taxable if the lender doesn’t get paid in full whether due to foreclosure, deed in lieu, or even a short-sale.  Although generally the foregiveness is shown by the lender giving you a 1099 tax form, the tax code doesn’t require this.  So, if your home short-sells for $100,000 less than you owed, you now have $100,000 of taxable income….maybe.

In December, 2007, the Federal Government passed The Mortgage Forgiveness Debt Relief Act of 2007 which generally excludes debt forgiveness from taxation if  it occurs on your principal residence from 2007 through 2013 (there are some restrictions).   Many states have adopted similar laws providing the same relief for state taxes. However, California’s similar law ended 12/31/08. We’re awaiting a bill to extend it but with CA’s budget mess, this may not happen soon if at all.

So, they key point is that the Relief only applies on the home you actually live-in. If you rent out your home or leave it vacant and go live somewhere else. Your debt forgiveness relief may be lost and you may be looking at a high income tax bill from the IRS and your state.

If you need further assistance or have legal or real estate questions, feel free to e-mail me at sjbeede@bpelaw.com

WHERE WILL THE MONEY COME FROM…

Every week, I consult with property owners who are grappling with over-encumbered properties and running out of money to pay their loans. The key question is “what should we do?”  But the best answer depends on their situation. For an upside-down owner, there are really five choices:

1.  Wait It Out - real estate values move in cycles and already demand is pushing prices up in some markets. Most investors think we’ll see upward movement in the next 2 years, although a return to 2006 prices could take a lot longer.

2.  Modify Your Loan - Most of the recent real estate news concerns efforts to get lenders to “modify” their loans to make them affordable to the borrowers. So far, this is voluntary for lenders and the results have been to reduce payments but not the debt. And these have generally been limited to owner-occupied properties. The key is to connect with the person at your lender that has authority to make a decision. There are Loan Modification companies that can assist you with this process but check their success rates before paying them any money.

3.  Sell the Property - Selling an over-encumbered property requires getting the lenders to take the loss between what is owed and what it will sell for. This is called a “Short Sale”. The key to success is convincing the lender that it is in their best interest to cooperate. This involves a combination of: a)  your “Hardship Package” showing that you can’t pay; b) “Comparables” showing the true current property value; and c) knowing what recourse the lenders would have if the property doesn’t sell. What sinks most short sales is the lender demanding that the borrower sign a “Promissory Note” for any deficiency, although agreeing to pay something may be in the borrower’s interest. Be sure to use a knowledgeable, experienced Realtor to lead you through this process.

4.  Give the Property Back - Sometimes the Lender will be willing to take the property back through a “Deed in Lieu of Foreclosure”. This generally will not work if there are any junior liens plus it requires more investigative work for the lender.  Simply sending the keys back to the lender, ie: “Jingle Mail”, does nothing except give possession back to the lender.

5.  Foreclosure - Every state has laws that may allow the lender to take the property if the loan is not paid. This is called “foreclosure”.  The real issue is whether the lender can get a Judgment against you if they don’t get paid in full. While in most states this is possible, it is not the norm. In California for example, if the lender uses a “Trustee’s Sale” to foreclose (in approx. 4 months), they are barred from getting a judgment against you. In contrast, the “Judicial Foreclosure” required to get a judgment could take 2.5 years. So, step #1 is to check your state’s foreclosure laws. For most borrowers, the real risk of a Judgment comes from those junior 2^nd or 3^rd loans that get “wiped out” by a senior lender’s foreclosure. Depending on when the junior lien was created, the foreclosure might only wipe out their security, not the debt leaving the junior able to sue you for the unpaid loan. So, it is critical to know what loans are on your property and when they were obtained.

No general review can determine what’s best for you. Getting competent legal and tax advice is critical as is your education.