NEW ASSET PROTECTION TOOLS - Mortgage Foreclosure Deficiency
Many Florida real
estate investors are concerned about personal liability from
mortgage foreclosure deficiency judgments. Although they accept
loss of equity, if any, in property which is foreclosed by their
mortgage lender, people are afraid of a deficiency judgment.
A deficiency judgment refers to a mortgage lender’s judgment
against the borrower for the difference between the outstanding
balance of the mortgage note, plus costs and attorneys fees,
and the value of the property foreclosed. The property value
is determined on the date of the foreclosure sale. Personal liability from mortgage debt is today a principal reason for asset protection planning.
In Florida, a mortgage foreclosure does not automatically result
in a deficiency judgment. Just because you lose a property at
foreclosure does not mean you will remain personally liable
for money owed to the lende . To obtain a deficiency judgment
against the borrower the foreclosure sale the mortgage lender
has to file a motion for a deficiency after the foreclosure
sale, and the court must hold a separate evidentiary hearing
on the lender’s request for deficiency liability. At the
evidentiary hearing the mortgage lender has to show the court
evidence that the property’s value on the sale date was
less than the note balance. The borrower can get his own appraisal
or can use the government's tax assessed value as evidence of
value. If the property was worth more than note balance on sale
date the court will not give the mortgage lender a deficiency
judgment against the borrower. The borrower may present evidence
of value in the form of a formal appraisal or other less formal
opinions of value such as the local government's tax assessed
value.
During the recent real estate boom deficiency judgments were
uncommon because increasing real estate values brought home
values above note balances of defaulting mortgages. Additionally,
lenders could take back "upside down" properties and
hold them until the rising market made them whole.
Deficiency liability is a problem in a declining market. Up to this point in the real estate crash few mortgage service companies with conventional first mortgages have been
pursuing deficienty judgments, especially mortgages on owner occupied homes. Many attorneys and other experts speculate that first mortgage deficiency lawsuits will increase in the future as lenders resolve foreclosure backlogs and as they sell their deficiency rights to third party investors and collection firms. Florida law gives mortgage lenders five years to pursue a mortgage deficiency claim.
Second mortgage lenders and private
lenders are more likely than first mortgage holders to go after the borrowers by suing for default on the underlying promissory note. There has been a significant increase in second mortgage lawsuits since the beginning of 2009. Banks that made commercial loans to developers or builders almost always file a lawsuit against the individual borrower to enforceand collect upon the promissory note or personal guarantee of a business loan.
If a mortgage lender pursues a deficiency judgment you should hire an attorney to defend the deficiency. In many cases, an attorney can use procedural defenses and substantive lending law to defeat a deficiency claim, and the attorney can negotiate an acceptable settlement for much less than the total deficiency liability in most cases.
One way to avoid deficiency liability, or to modify your mortgage to avoid foreclosure, is court ordered mediation with your mortgage lender through a new mediation program in Chapter 13 bankruptcy cases. If you file a Chapter 13 bankruptcy in the Orlando division the the federal bankruptcy court will very soon after filing issue an order requiring the lender to participate in good faith mediation to discuss mortgage modification.
Another problem with mortgage foreclosure is possible income
tax consequences. The general rule is that when a lender forgives
or cancels a debt the borrower can incur income tax on the amount
of debt forgiveness. When you arrange a discount in your mortgage
in order to sell house (a so-called "short sale")
the mortgage lender will cancel part of your mortgage debt and
you will receive a tax form 1099 telling the IRS that you have
imputed income for the amount of debt reduction. You will also
incur income tax liability for a deed in lieu of foreclosure.
The taxable income will be the difference between the property
value and the balance of the mortgage loan on the date you surrender
the property to the bank.
A foreclosure may result in cancellation of debt income depending
on whether the bank pursues a deficiency judgment. If the mortgage
lender gets a deficiency judgment for the difference between
the property value on foreclosure sale date and the mortgage
balance the lender is not forgiving any part of the loan. If
the bank chooses not to pursue a deficiency judgment, or pursues
the judgment unsuccessfully, the borrower may incur income tax
liability for debt foregiveness.
In December, 2007,
Congress acted to protect many debtors from income tax liability
associated with foreclosure avoidance. The Mortgage Forgiveness
Debt Relief Act of 2007 states that homeowners will not be subject
to income tax from release from mortgage liability if and to
the extent the mortgage proceeds were used to buy or
improve their primary residence. There is no income
tax shelter from foregiveness of mortgage debts for investment
property, vacation homes, or mortgages used for businesses or
to pay off credit card balances. The protection expires in December,
2009. You should speak with an attorney or CPA familiier with
the new law to see if you qualify for income tax protection.
For those borrowers who do not qualify for protection of the
new Act there is an insolvency exception to imputed income from
the cancellation of mortgage debt. If a borrower is financially
insolvent when he surrenders the mortgaged property to the lender
voluntarily or through foreclosure there will be no imputed
income. A borrower who files bankruptcy is presumed to be insolvent,
so that a bankruptcy debtor cannot suffer imputed income tax
liability because the bankruptcy discharges personal liability
under a mortgage note. More information is available from IRS
Publication 908 and IRS tax form 982. Both forms can be found
at irs.gov.
The tax law permits many real estate investors to offset imputed debt foregiveness income with corresponding tax losses. For example, if a lender forecloses on a parcel of income producing rental property the taxpayer may be able to report an operating loss to offset all imputed income from debt foregiveness in the same year that the the mortgage lender issues the Form 1099. When a foreclosed property was not income producing, but was held solely for future appreciation (example: vacant land), the deduction from ordinary income of capital losses in excess of capital gain may be limited to $3,000 per year so that the total loss will have to be deducted over future tax years. You should consult your CPA to determine the tax impact of a mortgage foreclosure on your tax situation. The tax impact of foreclosure is not a legal issue.
