What is Your Role as a Real Estate Agent or Investor when Explaining a Deficiency or Tax Liability to Your Client?
In today’s real estate environment, it seems like everything that is either bought or sold is a short sale. With a successful short sale comes a host of other sometimes unknown things; two of them being either a potential deficiency judgment or tax liability to the seller. When it comes to determining how these two issues affect a seller; there is much confusion and controversy about a lender’s rights to pursue them for any deficiency or tax liability.
Any amount that is not satisfied by selling the home is money lost by the lender, the larger the discount—the greater the loss. In order for the lender to recoup some of the loss, the lender may take the following actions: pursue a deficiency judgment; ask for a promissory note, ask for cash at closing, or send the seller a 1099 for the “phantom income.” With that being said, whether you are a licensed real estate agent or an investor, you must not only alert sellers to the potential for these responses from the lender, you must also inform them as to their options for dealing with them.
When the seller receives a 1099 from the lender, they may qualify for relief under the Mortgage Debt Forgiveness Act and complete a Form 982 to hand to their accountant with the 1099 when they do their taxes (for more details go to www.irs.gov). Two major points to consider as to whether or not the seller can qualify: this Act only applies to the seller’s primary residence, and the seller must show that they are insolvent (their expenses outweigh their income). If they qualify for debt relief, they may be able to avoid tax implications for all loans used for the original purchase or for direct improvements under the Mortgage Debt Forgiveness Act. For investment properties or cash-out refinance loans, the seller will be held responsible.
It is also important to research whether you are in a recourse or non-recourse state. The loan may initially have been set up as a recourse loan, or a non-recourse loan, however the home state will also come into play. With a recourse loan, then the lender can come after the seller for the difference. With these types of loans, the lender will typically approve a short sale for a reasonable amount because they know that they still have the option to pursue more money later, when the seller gets back on their feet. Although even with this freedom, it still doesn’t guarantee that the lender will come after the seller for a deficiency judgment. If the seller has $0.34 to their name, then the lender obviously understands that there is nothing to gain, and won’t waste their time.
In a non-recourse loan, be prepared to deal with a lender that either won’t take a short payoff at all, or that will demand a large sum of money at closing, because they know that this will be their one shot to recover as much as they can. In much rarer cases, the lender may try for a deficiency judgment, but it’s highly unlikely, because unless there is fraud involved, or the seller doesn’t show to court…then they won’t win. Again, keep in mind, the law is different state to state, so it is important to know how the law applies in your home state because it still affects the seller’s future liabilities.
Regardless of what MIGHT occur with your seller, always be certain you are clearly expressing ALL possible consequences and referring your sellers to the proper resources! For more real estate industry articles and videos visit www.RealEstateBusinessMentors.com or visit www.AskBobLachance.com for any real estate questions.
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