Monthly Archives: January 2010

Unwelcome surprise: 1099 after foreclosure and short sale

foreclosures-shortsales

There is an unpleasant aftershock from a foreclosure or short sale.

A client received the 1099 below last week after the foreclosure of his home. Lenders will issue a 1099 to the borrower after foreclosure and, surprise, the client will owe income tax on the amount in the 1099. The client was quite distressed to get this in the mail.

The 1099 means that he has $189,385.26 more in taxable income for 2009. That is because when a mortgage is foreclosed, it is deemed to be  “forgiveness of debt” and it is counted as income to the borrower, due to the fact that the borrower does not have to repay the mortgage.

Fortunately, since this was the client’s primary residence and, while he must report the 1099 on his taxes,  he can exclude the 1099 from his income. Form 982 is used to exclude the 1099 from income. This was the client’s primary residence and there is an exclusion for primary residences only (no vacation homes or investment properties get this benefit). Had this not been his primary residences (for any 2 of the last 5 years) he would have owed about $60,000.00 in income taxes, which, of course, was money he did not have.

It is always a good idea for a borrower in financial trouble to try to sell the property at a “short sale” before going through foreclosure. Why? First, in a short sale you can at least pay back some of the mortgage and the amount reported on the 1099 issued after closing by the lender will be less than in a foreclosure. After a foreclosure, the entire amount of the mortgage is 1099’d to the borrower.

As I wrote recently, after a short sale or foreclosure, a lender is required to issue a 1099 for the amount that was not repaid.  The lender can also pursue a deficiency judgment against the borrower.  In Illinois, most lenders on first mortgages are simply issuing 1099s after foreclosures and short sales. They are not seeking deficiency judgments, although they could do so. Technically, the lender can do both of these:  a.) 1099 the borrower and  b.) seek a deficiency judgment, but that rarely happens. In practice, most lenders just issue 1099s and don’t pursue deficiency judgments. However, borrowers have to be aware that the issuance of a 1099 does not cut off  liability for signing the note.

Second mortgages are another story and many of those are being turned over to collection agencies, rather than the lender seeking a deficiency judgment.

Many clients are not aware of the 1099 issue. So the best route if you are in financial trouble with real estate is:

  1. File for a loan modification first (although it’s easier to get hit by lightning than to get this approved). The only reason to do this is the new short sale rules that start soon require a loan modification first, before a short sale.
  2. List the house for sale and try to get the lender to approve short sale.
  3. Ask the lender in the short sale for a “no deficiency” payoff, especially if the property is an investment property.
  4. Beware that a 1099 will be issued after a short sale or foreclosure and file form 982 to exclude the 1099 from your income.
  5. At the worst, if the property was not your primary residence, you will have to file for bankruptcy to get rid of the income from the 1099 after the short sale or foreclosure. However, as this excellent post points out, the bankruptcy has to be filed before the 1099 is issued, not after. A bankruptcy filing after the 1099 is issued will not discharge the 1099 income.

Cook County tax first installment 5% higher

Real estate tax

I got my first installment of 2009 tax bill in my mailbox on Saturday. To be honest, I didn’t even open it. The first installment of taxes was always 50% of the last tax bill. There are no big increases in the first installment. It’s kind of dull.

Many are complaining (rightfully) that the installments are too close together. Another thing to complain about is this: The first installment is now larger than in previous years. It’s now 55% of last year’s tax bill.

Foreclosure and deficiency judgments

Bankruptcy, foreclosures-shortsales, Real estate tax

One sign of a terrible economy,  to me, is how many times per week I discuss with a client how foreclosure works. Clients are worried about foreclosure, but they are especially fearful that the foreclosing lender will obtaining a deficiency judgment against them.  If you check any real estate advice website like Trulia, there are many, many people asking about the effects of foreclosure and how deficiency judgments work. (Update: Illinois courts are now entering deficiency judgments routinely on first mortgages. This post discusses the increase in deficiency judgments.)  Here’s how  deficiency judgments work in Illinois:

Are deficiency judgments allowed in Illinois?

Yes.

What is a deficiency judgment?

If a property is foreclosed, it is sold at a sheriff’s sale. If the property owner owed $100,000 on his mortgage when he was foreclosed, and the property is sold at the sheriff’s sale for $80,000, then the lender can get a deficiency judgment for $20,000.00. This means a court order is entered saying that the owner owes the lender $20,000.00. (As discussed below, obtaining a judgment and actually collecting the judgment are two different things.)

When is a deficiency judgment entered?

Usually, the deficiency judgment is requested in the foreclosure complaint. The judgment is entered at the foreclosure sale confirmation hearing after the sheriff’s  sale at the end of the foreclosure.

Can the lender get a deficiency judgment if I was served by publication in the foreclosure?

No. You have to be personally served by the sheriff or process server. The lender cannot get a deficiency judgment if you were served by publication (as many homeowners are). Another way to get a deficiency judgment entered against you is if you file an “appearance” in the foreclosure case.

What are the chances of the lender coming after me for a deficiency judgment?

If the property was your primary residence, the chances are slim (my  estimate, totally unsupported by facts or statistics, is 5%) that a deficiency judgment will be entered. Very few deficiency judgments are being entered in Cook County according to attorneys I know who practice in the foreclosure area. If the foreclosed property was investment property ,or the mortgage was held by a small local lender, then the chances of a deficiency judgment increase greatly.

What can the lender take from me if they get a deficiency judgment?

A deficiency judgment is like any other judgment that is entered for an unpaid medical bill or unpaid credit card. After the judgment is entered,  the judgment holder serves you with a “citation to discover assets” and you have to go to court and produce a copy of your tax return and a list of your assets.  They use this information to garnish your wages or to take any non-exempt assets from you to pay the judgment.

What assets are exempt from collection after a deficiency judgment?

These items are exempt from judgment:  Life insurance, 401ks, IRAs, $15,000 in equity in a house ($30,000 for a married couple). If your house is titled as Tenancy by the Entirety (married couples and primary residence only) and provided the judgment is only against one, not both, of a married couple, then the entire house would be exempt.  Since we are talking about a foreclosure, it is unlikely that the judgment debtor will even have a house to worry about.  85% of wages are exempt from garnishment too.

How can I get rid of a deficiency judgment?

The only way to get rid of a deficiency judgment is to file a chapter 7 or chapter 13 bankruptcy. A chapter 7 wipes it out altogether. In a chapter 13, it is partially repaid.

Can’t I just give my other assets to my relative to hold for me?

You can gift assets to a relative. But any transfer to a relative or anyone else that is not “for value” can be undone as a fraudulent transfer.  Transfers to relatives are especially suspect. In addition, there is the risk that your relative will not repay you or may get divorced or file his or her own bankruptcy.

If my lender does not ask for a deficiency judgment in the foreclosure, can my lender file suit against me for a deficiency judgment after the foreclosure?

Yes, Illinois law specifically allows a lender to file suit against a borrower after a foreclosure as a separate collection lawsuit.  With first mortgages, this is very rare and most likely will not happen, unless the lender is a small bank or the property was not your primary residence. Some lenders holding foreclosed second mortgages (especially Citibank and Wells Fargo) now hand over the loans to collection agencies to file a separate lawsuit against the homeowner for breach of contract. Read more about that here.

Can my lender file suit against me for a deficiency judgment after I sell my house in a short sale?

Yes. The best practice is to negotiate a “no deficiency”  provision in your short sale.  If you can’t  get that from the lender, then you will have to wait it out and hope that the lender does not ask for a deficiency judgment in the future. Most likely they will not pursue the borrower, but you never know for sure.

If I deed my property back to my lender in a “deed in lieu of foreclosure” can my lender get a deficiency judgment against me later?

No. The lender cannot get a deficiency judgment. Unfortunately,  a deed in lieu of foreclosure is kind of the equivalent of a unicorn; one doesn’t exactly show up in your back yard every day.

How long is a deficiency judgment last?

A judgment in Illinois is valid for 7 years from the date it is entered.

I’ve heard that in a foreclosure my lender can 1099 me for “forgiveness of debt.” Can they 1099 me and get a deficiency judgment against me too?

Usually, if a lender 1099s you, the lender will not seek a deficiency judgment. This is just how lenders operate, not the law.  By law, the lender must issue a 1099 after a foreclosure or short sale. The issuance of the 1099 does not mean that the debt is erased by the lender. It just means that the forgiven debt is taxable to you.

If the lender 1099s you and later seeks a deficiency judgment, the lender would have to issue a revised 1099, that’s all. So the issuance of a 1099 does not bar a deficiency judgment. Technically, the lender can 1099 you AND file for a deficiency judgment. You have to keep in mind that the lender could still get a deficiency judgment after a 1099 is issued. The only sure elimination of both the 1099 and deficiency judgment is to file bankruptcy before the 1099 is issued.

There are several cases that deal with this topic: In re Zaika, a PA bankruptcy court case  and AmTrust v. Fossett in AZ are a couple that summarize the law.

If the foreclosed property was your primary residence,then you have no income from the 1099 by law under the Mortgage Debt Forgiveness Act. If the property was not your primary residence, then you will have phantom income from the 1099 to deal with.

Best “cloud” programs

Technology

It’s become common to have computer programs hosted in the “cloud.” My favorite cloud programs are below:

(I use and like gmail, google calendar a google tasks alot, but they are so well-known I left them out)

  • Dropbox. I love this program. Any file that is saved in My Dropbox (which is just a folder in the My Documents area) is synched with all other computers. I synch all of my files on 3 computers and my I phone. I can access any of these files from any or all of these, including the I phone, anywhere there is internet access. The dropbox  interface is clean and easy to understand. This program is a total winner. It’s free too, up to 3 GB of storage. I pay for the $99 yearly upgrade to store 50 GB.
  • Dragon I phone application. I use Nuance’s Dragon voice dictation system on my main computer at work, although not as much as I used to. In December, the company released a free Iphone  application that lets you dictate into the I phone and then you can email or text the resulting message. It’s a big time saver and provides a break from the tyranny of typing messages into the I phone. It recognizes speech very well.
  • Timedriver. This is my second favorite program. Timedriver lets clients make appointments without playing phone tag forever. I have a link on my website that the client clicks. The client chooses a time and date and then the appointment is put in my Google calendar automatically. The cost of this is $30 per year and it’s worth 10 times that amount.
  • Basecamp. This is an extranet program that I have used for three years for active real estate and trust and estate planning matters. It is phenomenal and costs only $49/mo. Clients are notified by email if a new file or email is posted to their private extranet. File sharing and email sharing are made simple with Basecamp.
  • Highrise. I used ACT contact manager for years. ACT had a bloated upgrade every year and had too many features for my humble office, so I switched to Highrise about three years ago. It is $24.00 per month and is a basic, utilitarian contact manager for storing notes, email and data about a client, but it works for me.
  • Authorize.net.  I ‘ve  accepted credit cards from clients for years. Last year I got rid of my account with Moneris and my expensive card-swiping machine. I applied for an authorize.net account using powerpay.biz. This is an internet payment gateway that allows me to accept credit cards online. I no longer have a card swiping machine. I can take credit cards on my Iphone, but I generally use Freshbooks, described below, to email an invoice to a client and the client pays by credit card online. Works wonderfully.
  • Freshbooks. Freshbooks is a time-tracking and invoicing program. I used Quickbooks for invoicing for years, but once I tried Freshbooks I never went back to Quickbooks (for invoicing that is; I still use it as a basic accounting program). With Freshbooks, you can send invoices by email to the client and the client can either print the invoice and mail a check, or pay by credit card online (you need an authorize.net account for this feature to work). The interface is clean and easy to use. I pay about $20/month and it’s well worth it.
  • Evernote. Evernote is a free program that lets you capture clips of websites. This replaced delicious for me and I use it to bookmark sites. There is an easy-to-use Firefox add-on that lets you capture any site in a single click. The best part about it is the Iphone application that remembers all of the sites for easy access anywhere.
  • Jungledisk. This is a good file backup site. You pay only for what you upload to the site and it’s worked well for me so far. Once you select the files or folders that you want to backup, the software takes care of it for you every day.

Update on new short sale rules

foreclosures-shortsales

Everyone is tired of short sales because only about 20% ever close. Some lenders have started to automate short sales, which may help.

The newest thing in the short sale arena is a program starting in April 2010 that supposedly will simplify short sales. The new program is called HAFA (Home Affordable Foreclosure Alternatives). It is incredibly complicated (like most government programs) and it does not apply to Fannie Mae (FNMA) loans. FNMA loans account for about 55% of all mortgages.

This wonderful post summarizes the HAFA program very well. HAFA is a sister program to HAMP, which is the totally ineffective mess of a program that tries to help homeowners modify their mortgages. Loan modifications have been so unsuccessful that a homeowner has almost as good of a chance of winning the lottery as having his or her loan modified. In fact, before pursuing a short sale approval under HAFA, the homeowner has to first apply for, and not qualify for and be denied or not complete, a loan modification under HAMP (that shouldn’t be too hard since none of the modification programs work at all).

A lender that chooses to participate in the HAFA short sale program will be paid by the US government. Hopefully, this will be enough of an incentive to get lenders to participate in the short sale program.

Here are some good things about the HAFA short sale program:

1. The homeowner/seller can get “pre-approved” by the lender for a short sale.

2. The homeowner must be released from future liability.

3. Real estate commissions can’t be reduced by the lender.

4. Best of all, the program sets timelines for responses by the lender. Short sales so far have been slow moving death marches that average about 6 to 7 months to get an approval. The lender has 10 business days to respond to a short sale offer.

Some not so good things about HAFA:

1. Must first apply for HAMP loan modification (have fun with that… virtually none of these get approved).

2. Must be borrower’s primary residence, no investment properties.

3. Mortgage must be delinquent (some short sales are current).

4. Complicated program with 43 pages of instructions.

Overall, I would say that this is a step in the right direction and an attempt to bring order to the short sale maze.