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.
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 lender . 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. In the current
real estate recession, more lenders may pursue deficiency judgments.
Up to this point in the real estate crash few lenders have been
pursuing deficienty judgments. Second mortgage lenders and private
lenders are more likely than first mortgage holders to go after
deficiency judgments. Even in a weak market, if there is still
equity in your property when you relinquish the property through
foreclosure you can defend a motion for deficiency judgment.
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 can be found at irs.gov.
