Written by design on January 19, 2012 – 5:02 pm
Recently I’ve had a number of inquiries from clients, realtors and friends on some key short sale issues and the interaction with bankruptcy and taxes. If these interest you or anyone you know or work with, please consider the outline that follows. My reference to “borrower” is to the borrower on the loans, which would also be the seller in the short sale transaction.
Anti-Deficiency Legislation (Foreclosure): When the lender agrees to accept less than what is owed to release its lien to allow the short sale to close, the release of the lien is not the same as releasing the borrower from personal liability on the debt. CA has anti-deficiency legislation under CA Code of Civil Procedure, Section 580. CCP 580d says if a lender forecloses by a non-judicial foreclosure, then that lender cannot sue the borrower for any deficiency when it later re-sells the property and doesn’t get enough proceeds to pay the debt in full. CCP580b says if the loan was part of the original purchase price of a residence for not more than 4 families and the borrower was occupying all or part of the property, and the loan was never refinanced (usually referred to as a “purchase money” deed of trust), then the lender also cannot sue the borrower for a deficiency.
Recourse v. Non-Recourse: Typically, when you’re doing a short sale, the first deed of trust holder is looking to foreclose or already has a foreclosure pending. The junior lien holder has to decide is there enough equity to justify incurring the expense to foreclose. If the answer is yes, and it were to foreclose, then there’s no deficiency. If the answer is no and the first deed of trust holder were to foreclose, then the lien of the second deed of trust holder is extinguished at the foreclosure sale and the obligation of the borrower to the lender becomes unsecured (the junior lien holder is now a “sold out” junior lien holder). If the junior lien holder loan was part of the original purchase price of a residence and not refinanced, then the sold out junior lien holder cannot sue for a deficiency (which makes it a “non-recourse” loan). However, many times the junior lien debt was refinanced or was added after the purchase, and then the holder can sue for a deficiency (which makes it a “recourse” loan).
In the past, if you were negotiating on a short sale with a junior lien holder on a debt that was a recourse debt (not a purchase money deed of trust), then the goal was to get the lender to confirm in writing that they were releasing the borrower from personal liability on the debt in addition to releasing the lien. Unfortunately, this was hard to get done. The consequence to the borrower without a release of personal liability on a recourse loan was that they were still liable for the unpaid balance.
Anti-Deficiency Legislation (Short Sale): CCP 580e has been added to the CA Code, and was modified in July of 2011. Now if a lender (senior or junior lien holder) consents to a short sale for a residential property of 4 units or less in CA, they are explicitly giving up the right to sue for any deficiency and they cannot obligate the borrower to pay funds beyond any sales proceeds at the close of the short sale escrow or later.
Interaction with Bankruptcy: If the borrower will have personal liability on a junior lien, and/or has other debts that may require the borrower to file bankruptcy, then depending on the borrower’s income he may need to file the bankruptcy before any short sale or foreclosure sale to be eligible under the Means Test for Chapter 7 bankruptcy. I recommend such borrower contact a qualified bankruptcy attorney like myself at least 60 days or more before any foreclosure sale or short sale to make that determination. They can always pursue the short sale after the bankruptcy, but bankruptcy court approval is required if the bankruptcy case is still pending.
Tax Consequences: Keep in mind that there can be gains tax and cancellation of debt tax consequences arising from a short sale or foreclosure. Your client should be consulting with their tax advisor to confirm those consequences, if any. If your client will incur a cancellation of debt tax consequence, they should confirm with their tax advisor if that consequence would be eliminated with a bankruptcy filing before the short sale or foreclosure sale.
I hope this information assists you. If you have any questions about it, give me a call. In the meantime, if you run across anyone who needs to look at bankruptcy as an option I’d greatly appreciate your referral.
Gary Gale
Bankruptcy Attorney
Law Office of Gerald L. White
111 Woodmere Road, Ste 240
Folsom, CA 95630
Office: 916-985-3330
Email: jerry@gwcreditlaw.com
