Every upside-down property owner is aware of the risk of a lender seeking a deficiency judgment for any amount of the loan that remains unpaid after short sale or foreclosure. Depending upon the laws of the state where the property is located, they may or may have any such right.  This issue of “recourse” is the first thing that I, as a real estate attorney, look at when advising borrowers and is the #1 reason that short sales fail (learn more in previous blogs).  But lately the question has been arising about whether a Mortgage Insurance Company has recourse if they pay-off a deficiency.

Private Mortgage Insurance (generally called PMI) is typically required by a lender anytime you borrow more than 80% of the purchase value of the property being acquired. In essence, you buy an insurance policy to protect the lender from the increased risk of loss with a higher loan-to-value ratio.  So you pay and the lender is the beneficiary. Here’s where it gets tricky.  An insurance policy is a contract between you and the insurance company for the benefit of a beneficiary. Like any agreement, the rights of the parties are governed by the terms of the contract and the laws of the State.  You pay for the policy in order to get the benefit of the lender giving you the loan… not for the benefit of avoiding a deficiency if there is a default (although this may be a reasonable belief if it is even considered at the time of the loan).  Thus, the policy may protect the lender from a deficiency and protect you from the lender’s claims but the policy may also provide that you must reimburse the insurer for any such payouts.  This is similar to your auto insurance which may pay a damaged third party for injuries suffered in an accident which you caused. The policy pays the injured party and you may have to reimburse the insurer for all or a part of what they pay out.  Again, the language of the insurance contract governs the rights of the parties.

But in the upside-down homeowner situation there are additional confusing issues. First, there must be an actual deficiency between the amount owed and the amount the lender receives.  If the lender has no recourse, they’ll generally give you a 1099 from which you may be liable for debt forgiveness tax.  But, if the debt has been forgiven, how can the PMI insurer claim recourse?  Second, since the insurer is communicating with the lender and not you, how can they hold you liable for a claim of which you had no knowledge and no input?  Third, since the only real purpose of the PMI is to insure injury resulting from a default by the borrower, then - unlike the auto accident - it is the default that is being insured, not obtaining the loan and therefore there should not be any recourse right for the insurer.

As of this point is time, we are not aware of any cases in which insurance companies have actually filed lawsuits against borrowers seeking PMI recourse. Such cases may be going on at the local Court level and have not reached the visibility (and legal authority) that only arises from an appeal after a Judgment to a Court of Appeals.  Given that a breach of contract claim such as failing to reimburse an insurer must be brought within a certain period of time after the breach occurs (such as 4 years in California), we may wait a long time before there is any certainty how Courts will treat such claims.  Further, if and when those cases are brought, there may be a great difference in rulings by different courts. It is the appeals process that starts to bring uniformity to decisions.

So the short answer to whether a Mortgage Insurer can get a Deficiency Judgment is “maybe”.  However, as set forth above, if any such suits are brought there many defenses that borrowers can argue to protect themselves. Even more effective may be the reluctance of judges and juries to further punish upside-down borrowers especially when the lenders (that arguably created this problem) get made whole.

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/.  

For upside down property owners, 2009 was a year of frustration and hype with little if any assistance. 2010 will likely be the same. Two key factors have become clear: 1) the unwillingness of lenders to cut principal balances for existing owners; and 2) the lack political will of our government to force any such cut. Back in 2008 when Hope for Homeowners was first ballyhood across the nation, the concept was that lenders would make more money by reducing existing loan balances and keeping owners in their homes than they would make if they foreclosed and put the property back on the market as an REO. The problem was that lenders disagreed. Lenders believed they would be better off getting what they could now and getting the property in the hands of a more financially stable owner. With loan modification failure rates running over 50%, there could be some validity in that belief. When President Obama was elected in 2009, he gave us the Obama Real Estate Recovery Plan the most valuable tool of which was the proposed Chapter 13 Bankruptcy Reform which would allow Federal judges to “Cram Down” principal values if the lenders wouldn’t. Unfortunately, the Senate wouldn’t go along and so the Plan failed. Instead, the government put forth the “Home Affordable Modification Program” which to date has produced very few home saving modifications.

So what to expect in 2010?  Here are my predictions:

1)  For Existing Property Owners  - Government will continue to tinker with the HAMP program to try to get more lender cooperation. The key obstacle will remain principal reduction. As lenders continue to refuse to make cuts, pressure is building to re-introduce the Bankruptcy cram-down legislation.  Look for increased lender cooperation with HAMP to avoid the cram-down but it will likely be too-little, too-late to avoid large scale foreclosures in 2010;

2)  Foreclosures - As of the new year, there are over 400,000 homes in pre-foreclosure nationwide, over 125,000 in California alone. Without an effective modification program, more owners will realize that it is time to move on and will either walk-away or attempt a short-sale to minimize credit and tax damage.

3)   Short Sales are the Market - For 2010 and probably for several years after, Short Sales will become the primary means of transferring homes.  Lenders have managed to stabalize prices by holding back on foreclosures and listing REO’s but there is a tremendous backlog of upside-down properties that need to be dealt with. Short Sales offer both seller and lender the best solution. The big obstacle - lender demands for recourse against the seller - is changing. Even BofA has dropped their recourse demands. Short Sales will be the path to market recovery although don’t expect prices to start climbing. Right now inventories are low so there has been some upward price movement due to supply and demand. As lenders get their short sale act together, and Realtors become more effective at negotiating and packaging these deals, more properties will come onto the market. Though this will keep prices down, more properties will be sold and we’ll all get through this housing bust faster.

4)  Commercial Real Estate - the big unknown - in 2010, our attention will shift away from upside down homes (that issue is being resolved) and will turn to fears of business collapse and loss of jobs. According to commercial broker, Grubb & Ellis, we’re approaching the highest vacancy rates since the dot com bust, with office vacancy reaching almost 20%.  With banks still fearful of lending and individuals fearful of spending, this double-whammy put more and more companies out of business and with them went a loss of jobs that has continued the downward spiral.  While few expect that these conditions will create a Depression-style generation of non-spenders, clearly the debt-fueled spending of pre-2006 is over. Bob Bach, senior vice president and chief economist at Grubb & Ellis put it clearly: “Retailers and owners of retail real estate will need to adapt to a ‘new normal’ in consumer attitudes that may last for some time, including more conservatism and attention to value as households rebuild their savings.”

2010 PRESENTS NEW OPPORTUNITIES - So what should you do going into 2010?  Get good advice. We are in a changed economy that is going to be with us for a long time. If the only economy you’ve known is the “go-go” days before 2006, get educated. Our economy operates on booms and busts which generally happen every 8-10 years.  You cannot simply sit on the sidelines and wait for things to get back to where they were. They won’t…. at least not for a long time.  But this new economy is full of opportunities for those willing to work hard and be creative. The US Dept of Labor estimates that more than half of all new jobs will be in in professional and related occupations and service occupations. Learn more at their website at http://www.bls.gov/news.release/ecopro.nr0.htm. I see a rise in demand for Short Sales Specialists;  Consultants in real estate; and small boutique service companies providing cost-effective services to businesses.  Production jobs will continue to disappear.

Lastly, I remain bullish on real estate investment despite having now gone through five down-turns including two crashes.  Throughout history, real estate has been the most stable long-term investment providing both shelter and income potential. This will remain so.  The danger in all investments is expecting continued growth which, if that happened, would not make it an investment at all.  Investment is the taking of “risk” in pursuit of the “potential” of gain. The risk will never go away nor the potential. So my advice to you is don’t give up on investing but keep your day job.

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/.  

One of the key questions I’m often asked is whether a seller/borrower should sign the consent agreements that the lender provides as part of their short sale. These agreements typically provide that the lender is only releasing its lien on the property but not the remaining debt. Depending upon the actual language used, the effect could be: 1) that the lender is only reserving its right, if any, to come after the borrower to collect the deficiency between what the lender receives from the short sale and what the borrower actually owes; or 2) that the borrower agrees that the debt continues and they will pay the deficiency.  While one can understand lenders seeking to protect their interests, it is legally unclear how enforceable such agreements will be if the lender actually seeks to collect.

Some lenders, such as Bank of America, have until very recently demanded that recourse language be in every Short Sale consent letter. Few if any lenders have written loans with non-recourse language for many years. During the past month, we know that BofA has dropped the recourse language from short sale consents in at least two short sales we assisted in.  The legal issue is whether the language in a short sale consent can alter the recourse or non-recourse nature of the original loan. We do not believe that it can. 

For example, in California where we practice law, if the loan in question is a purchase-money acquisition loan for a 1-4 unit property in which the borrower lived, that loan is non-recourse as a matter of law. For any lender to try to get around this with a short-sale consent is likely unenforceable. But we cannot know how the courts will ultimately rule on these if the lender subsequently tries to collect the deficiency. In a different situation, if the original loan was recourse, ie: not an acquisition loan, then the lender has a better chance at collecting on a deficiency because they had that right in the original loan. However, if there is only one loan on the home and it is a recourse loan, it is still highly unlikely that a lender would ever realistically pursue a judicial foreclosure in order to get a deficiency judgment. It costs too much and takes too long compared with a Trustee Sale which is relatively quick and cheap but bars them from a deficiency. These are the issues we look for in our consultations and it provieds the basis for the strategies in short sale negotiation.

Obviously, we always recommend seeking to strike recourse language from short sale consents. If the lender refuses, then it is a weighing of the risks vs rewards of signing anyway:

1. The Short Sale is better for the borrower because the credit damage is less and it doesn’t trigger the FHA and FNMA foreclosure blocks on further loans;

2. The Short Sale generally produces a higher price than a foreclosure so it reduces potential debt forgiveness taxes.

3. Even if the borrower signs the consent, it still may be unenforceable since arguably the borrower received no real benefit from the deal;

4. Even if the borrower signs the consent, it still may be unenforceable since arguably the lender has no right to waive taking the security and then suing the borrower.

Points 3 and 4 are the critical issues that the courts will likely deal with in the next 2-3 years if any such lender recovery suits get filed.

So, there is no one right answer to this question. The above examples are based upon California law. The law in other states may lead to different conclusions, especially in states that do not allow for Trustee Sales. Signing may make sense but I would always make sure that the seller/borrower understands the risks and rewards before making any recommendation.

I also appreciate that real estate agents are placed in a difficult conflicted position with shorts sales. If the seller signs the consent, the agent gets paid. If they don’t sign, the agent doesn’t get paid. While of course agents always look out for their client’s best interest and have a fiduciary duty to do so, the risk-reward equation is different for the agent than it is for the seller, especially when there would be no recourse (and no commission paid) if the property were foreclosed because the short sale failed.

So, if you are faced with the situation of deciding whether or not to sign the lender consent agreement in a Short Sale, be sure to get competent legal advice first from a real estate attorney in your state and be sure that they can advice you as well on the impact of debt forgiveness tax even if there is no recourse.

If you have specific questions about your California 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/.

As readers of this Blog are aware government efforts to help upside down homeowners keep their homes have been a failure.  First, lenders are not willing to make the principal cuts needed to bring loan balances to an affordable level; and second, government lacks the political will to force the issue.  But this does not stop them posturing.  Last year it was “Hope For Homeowners” and this year it is the “Home Affordable Modification Program”. Both promised loan balance and payment reductions. Both have been a failure since Congress has been unwilling to force the issue by passing Bankruptcy cram-down authority.  HAMP has been especially frustrating because lenders have been offering “trial modifications” with reduced payments but then refusing to continue that payment level after the “trial” period.  Instead, it appears to be nothing more than a short-term money grab.  So, as government officials fret about lack of lender cooperation, foreclosures continue to rise and the real estate market continues to be flooded with short sales and REO’s.  But there is improvement in short sale processing that will help stabilize the market.

Short Sales offer benefits to all parties:  the upside down seller minimizes their credit damage and can negotiate issues of deficiency liability;  the lender gets money now and reasonably gets more than they would through a foreclosure, the buyer gets a home at current market values, and most importantly, one more property is removed from the market thus moving us closer to a real estate recovery.  The sticking point remains lender unwillingness to give up on recourse against the seller/borrower but that has been changing in recent weeks most notably with Bank of America dropping its insistence on recourse is all short sales.  So, while this will not help owners keep their homes, it does help them and the market get on with life and move to a recovery.

Processing the massive amounts of short sale Hardship applications remains a time-consuming effort for lenders. Help may be on the way through new companies such as Mortgage Resolution Services (MResolution.com) which are developing standardized processing and lender negotiation systems that promise to expedite the approval.  As always, borrowers should get independent advice from a knowledgeable attorney as to what their potential judgment and tax liability is before going into any short-sale or letting their property go in foreclosure.

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/.  

In my last Blog article, I wrote about how lenders and collection agencies are falsely claiming that modifying an acquisition loan makes it recourse. Under California Civil Code Sec. 580b, loans made to enable a borrower to acquire (purchase) a 1-4 unit property in which the borrower resides are non-recourse. This means if the lender forecloses, they cannot get a money judgment against the borrower for any deficiency between the amount owed and the foreclosure sale price.  Several lenders are now similarly claiming that a Home Equity Line of Credit (”HELOC”) is recourse even if it was used to purchase the home.  This is a trickier question?

By its nature, a HELOC is a cross between a home loan and a credit card secured by the property. You get the funds up fron to purchase the property like any acquisition home loan. Then, as the HELOC gets paid down, you can draw out money again up to the original amount of the HELOC like you would with a credit card.  On one hand, if it is used to purchase the property, it certainly would appear to have all the characteristics of a purchase money acquisition loan and therefore should be non-recourse. However, since additional credit draws would be in effect new loan amounts not purchase money, these would reasonably be recourse loans.  Lenders would have us believe that this additional loan ability makes the entire HELOC a recourse loan. 

I disagree.

For most home purchasers using two loans, the reason was that the first loan would be 80% and thus mortgage insurance would not be required. The 2nd loan filled in the gap between the 1st loan and the Buyer’s down payment, typically 10-15% of the purchase price.  Since these are both necessary for the Buyer to purchase the home, these are purchase money acquisition debt and would be non-recourse (assuming 1-4 unit, owner-occupied).  For the Buyer, the title of the 2nd loan would not seemingly matter. Whether the lender called it a Home Loan, Home Equity Loan, or Home Equity Line of Credit would not make a difference to a Buyer who needed the loan to purchase the home.

As stated in the 1976 case of Union Bank v Wendland, “The antideficiency statutes indicate a legislative intent to limit strictly the right to recover deficiency judgments….the purpose of that antideficiency statute is to discourage the overvaluing of the security, and the risk of inadequate security because of overvaluation is placed on the purchase money mortgagee.“  Since the lender is placing a value on the property at the time of acquisition and is making a loan secured by the value of the property at that time, the anti-deficiency protection of Sec. 580b should apply to the HELOC just as it would apply to any other acquisition loan. The only difference between the HELOC and any other loan is that the lender allows the borrower to take money back out up to the original secured amount.  And unlike a credit card, the debt is secured. So arguably, even further draws back to the original amount could be non-recourse as well. As the court said in the Union Bank case, “…. the protections of the anti-deficiency statutes can not be avoided because of some clever paper shuffling on the part of the lender. To allow such is a circumvention of the anti-deficiency statutes.”

Can a lender get around this by having a provision in the loan documents stating that the loan will always be recourse?  That is unclear.  Court’s do not excuse a borrower from not reading and understanding their loan documents before they sign.  But, given the very unequal bargaining position of the parties, I expect that the Court’s would lean in favor of application of 580b.  We’ll have to wait and see how these cases turn out, if indeed any such cases are actually filed.

Of course, none of the above is going to stop unethical lenders and collection agencies from threatening and scaring borrowers into paying money on non-recourse debt. 

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.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.  

As regular readers to my Blog should know, under California law (Civil Code Section 580b), if a lender makes a loan to enable a borrower to buy a 1-4 unit property which they live in, the lender has no recourse against the borrower. They can only take (foreclose) the property. They cannot get a judgment against the borrower if the property is not worth the amount owed on the loan. This is called an “acquisition loan”.  If the borrower later refinances this loan by getting a new loan, this protection is generally lost because the new loan was not obtained to acquire the property.  That makes sense.  But what about a loan modification?

Recently, several clients have had lenders (or collection companies) tell them that their loans became recourse because they got a loan modification.  From what I can see, this appears to be false and is no doubt said in an attempt to collect some money even when there is no recourse.

The First reason that this is false is that the loan and security (deed of trust) have not changed. It is still the acquisition loan and the same date of purchase recorded security.  Second, there is a rule in law called “substitution”.  The substitution doctrine applies when an acquisition loan is refinanced by the lender holding the original acquisition debt. The acquisition portion refinanced retains its purchase money character and the anti-deficiency protections of CCP §580(b) apply. (Union Bank v. Wendland, 1976).  Further there is legal authority that the protection extends to situations where the “beneficiary of the purchase-money loan ‘refinances’ the loan, ie: same lender, borrower, and security, but different loan amount.  From these sources, it appears fairly clear that a modification will not alone convert a non-recourse acquisition loan into a recourse loan.  As the court said in the Union Bank case, “…. the protections of the anti-deficiency statutes can not be avoided because of some clever paper shuffling on the part of the lender. To allow such is a circumvention of the anti-deficiency statutes.”

 We recently had a case in which our client had bought a home using 1st and 2nd acquisition loans. When she later sought a $6,000 education loan from the same lender, the lender replaced her 2nd loan with a Home Equity Line of Credit (HELOC) which included the original 2nd loan amount of $76,000 plus the additional $6,000. When the market later crashed and our client was losing her home, the lender claimed that the new 2nd loan was a refinance and thus they had recourse. They then sued the borrower for the entire $82,000.  Clearly the Substitution Doctrine should apply here at least to the $76,000. Unfortunately,  other financial issues have forced our client into Bankruptcy so this will not get resolved, but based upon the Union Bank holding and other cases, we are confident that our client would prevail on her claim that the $76,000 is non-recourse.

Of course, none of the above is going to stop unethical lenders and collection agencies from threatening and scaring borrowers into paying money on non-recourse debt.

If you have specific questions about your 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.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.  

On Monday, October 12, 2009, Gov. Schwarzenegger signed Assembly Bill 260 which, effective January 1, 2010, will ban negative amortization loans and preclude mortgage brokers from earning special fees on these high risk loans. According to the Bill’s author, Assemblyman Ted Lieu, the intent is to ban the practices that led to the foreclosure crisis that eventually triggered the recession which we now suffer. This will be good news for some but offers no assistance for the millions who remain at risk of losing their homes under their existing negative amortizing loan contracts. Although lenders will stop making such loans, they have been extremely resistant to cleaning up (modifying) such loans.

As those of you who have followed my Blogs know, the negative-amortization loan was a program offered by lenders to make loans to people who couldn’t qualify for normal fixed rate loans. Because they were marketed on a very low teaser start-rate, a great many gullible borrowers signed up believing the promises that they could later convert to fixed rate or “flip the home” for a profit. Both of these incentives were the unintended consequences of our Government’s desire in the late 1990s to expend home ownership and the American Dream.  The result was that millions of people got loans to buy homes they could not really otherwise afford. When the adjustments started happening and the homes couldn’t be flipped, this expansion of the American Dream quickly became a worldwide nightmare that we’re still dealing with.

The sad reality in all of this is that the lenders were very familiar with the dangers of adjustable rate loans from the problems in the 1980’s but it didn’t stop them from taking the fees up front and setting up this house of cards which had to collapse.  Hopefully this new law will stop such risky practices in the future and compel the lenders to be trustee stewards of their investors’ monies and their borrowers’ expectations.

Possibly this new law will add additional fuel to the legal arguments raised by attorneys seeking to stop foreclosures of these high-risk and now illegal loans. Since it is not retroactive, it does not have any legal effect on existing loans but certainly may influence a judge or jury in determining whether a loan was predatory.

If you have specific questions about your 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.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/. 

With the stroke of a pen, Gov. Schwarzenegger signed Senate Bill 94 and put an end to loan modifiers who charge up front fees.  As reported in the Sacramento Bee today, the action comes following massive complaints to the Dept. of Real Estate comcerning loan modifiers who took borrower’s money - up to $4,000 - and then abandoned them. While not condemning all modifiers, the new law applies to every such company that collects up-front fees. 

Earlier this year, State and Federal crackdowns on loan modifiers limited such services to real estate licensees and mandated DRE approved contracts for any up-front fees. However, many simply ignored the restrictions. More significantly, the earlier law excluded attorneys. As a result, law firms quickly filled the gap by collecting up-front fees and then partnering with loan modifiers to do the actual work. The new law puts an end to this.

While protecting the victims of these scams, the intent of the law is to stop abuse of borrowers in trouble. Legitimate loan modifiers can still operate but they cannot get paid until they have performed all of the services promised in their contract with the borrower.  This does not require that payment only be made if the modification is successful.  Borrowers must pay the loan modification firm for the services they provided, even if the firm cannot get the loan modified. 

Furthermore, the modification firms must tell potential clients that they may be able to get the same services for free from government-approved nonprofit mortgage counsellors. You can find these by Googling under such names as “nonprofit mortgage counsellors” or “debt management consultants”. I would expect that with this latest crackdown, getting access to this free help will become much more competitive so don’t wait. Act now and be persistent.

The new law will expire on January 1, 2013 which coincidentally is the expiration date for the Federal Debt Forgiveness Relief Act.  Apparently the concensus in Washington D.C. and in California is that this real estate mess will be cleared up by the end of 2012 so loan modification protection will no longer be an issue.  We’ll hope that they are right.

If you have specific questions about your 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.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/. 

One of the advantages of counselling hundreds of upside-down property owners is that I get confronted with situations that may call for solutions outside of what we would normally expect. This is one of them.

A client bought their home for $500,000. Today’s value is at best $300,000 and they owe $340,000.  Because of the economic downturn, they can no longer afford the home and are facing possible foreclosure or a short sale. Generally, we advise owners to stay living in the home as their principal residence to take advantage of the Debt Forgiveness Tax Relief.  However, under our current tax law, an owner cannot take a capital loss on their personal residence. So, my clients would lose the benefit of writing off the more than $200,000 investment they have lost.  In meeting with them, I realized that the amount of taxes they would save on Debt Forgiveness Tax Relief would be approx. 33% on the $40,000 of debt forgiveness, or $13,000. In contrast, the tax savings available by writing off their $200,000 capital loss would be $66,000 but to get this, they would have to turn their personal residence into an investment property.  Since I’m not an accountant, I advised them to check with their tax advisor or a CPA to determine if they could do this and, if so, how it would be done.  But that launched my own investigation which appears to confirm my suggestion.

One internet contributor, www.realestatecolorado.net, identified the key issue as how long one must have the property as an investment (”rental”) to get investment property treatment. They state: “although there is no defined “holding period” to be considered “held for investment,” many tax/legal advisors believe 1-2 years is sufficient barring any factors which contradict an investment intent.”  So, the key is to be intentionally holding the property as investment.  Another resource, The Center for Financial, Legal and Tax Planning, Inc., at www.taxplanning.com/takingacapitallossonyourhouse.html, provides an excellent explanation of the process and similarly concludes: “To cement the property as being a rental, renting the premises for two years should be sufficient to peg the property as a rental.”   So again, it is demonstrating investment intent over time.  The Center also notes: “As well as renting the property, the taxpayer should be cognizant of the little details that the IRS looks to in order to prevent the taxpayer from taking a capital loss.  Such items as having your name on the utility bills, using a regular personal residence mortgage and applying a homestead exemption for local taxes, must be changed in order to cripple an IRS argument that the property is actually a primary residence as opposed to being a rental property.”

Now back to the main question: Can a couple facing foreclosure on their personal residence rent the property out, give up the debt forgiveness tax relief, and get the capital gain write-off?  The answer appears to be “Yes” if they can be convincing that the change was done for investment intent.  It is unclear how the two year intent benchmark is measured, whether that is calendar years or tax return years.  Thus, my clients facing a 2010 foreclosure could theoretically rent their home now and show it as a rental on their 2009 tax return. Then, when the home is foreclosed (or sold short) in 2010, it would appear again as a rental on the 2010 tax return.  Two years showing as a rental on tax returns may be sufficient.  Would the IRS deny investment intent if the property loan is unpaid and foreclosure is forseeable? It is possible.

Certainly, the benefits of making the change could be worth it if successful.. plus you’d get the rental income during the interim.  But don’t take my word as advice to you on what to do . If this appears to be an approach that could benefit you, contact your CPA or tax advisor and get their advice and guidance for your particular situation and rely upon their recommendations. They would have to defend you against an IRS challenge. It certainly is worth checking out further.

If you have specific questions about your 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.  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/.