by Eric N. Allen October, 2011
For at least 20 years prior to the real estate market crash in 2008, the primary concern of every homeowner selling a home was how to properly deal with the capital gain. If the gain was reinvested into a new home, the gain was excluded from income. In addition, each taxpayer receives a $250,000 ($500,000 for married couples) exclusion from capital gains for the first gains that are not reinvested into a new home.
However, since 2008 and the decline of the real estate market, concerns have shifted. In addition to assisting clients who are lucky enough to sell their homes at a profit, we are assisting clients who may be in the process of losing their homes or finding it necessary to sell their homes at a financial loss. Brief answers to the most common questions that we receive on these subjects follow:
Question: What do the terms foreclosure and short sale mean?
Answer: A foreclosure is a lawsuit through which a secured lender (the mortgage holder) sues for a judgment and the subsequent sale of your home. The end result of a foreclosure suit is a public sale of the home by the county sheriff. The home is sold to the highest bidder, who may be your mortgage lender, an investor or another person who is interested in acquiring your home. Banks generally will bid no more than the mortgage balance at the sale and will frequently bid much less. A short sale is a voluntary sale of your home for an amount of money that is less than the balance on the mortgage. In order for a short sale to occur, the mortgage lender must agree to accept less than the balance due on the debt. The agreement on the part of the mortgage lender is voluntary -- you cannot force the lender to accept less than the balance due on the debt.
Question: How long can I remain in my home after a foreclosure suit has been filed?
Answer: Indiana law provides that a homeowner may continue to reside in his/her principal residence until such time as the home is sold at sheriff's sale. This right to remain in the home can be as short as three months, if the homeowner chooses not to defend the lawsuit and thereby defaults; or it can be extended for a year or longer if the homeowner defends and forces the mortgage lender to prove the validity of its case. The homeowner can stay in the home for that time period even if the owner is not able to make the mortgage payments.
Question: What if my home sells at sheriff's sale for less than the judgment that the mortgage lender has against me?
Answer: Indiana is one of the majority of states that allow mortgage lenders to collect the difference between the amount of the judgment and the sale price of the home. For example, if the judgment awarded the mortgage lender is $125,000 and your house sells for $75,000, then that means that the mortgage lender will have a $50,000 deficiency judgment against you. Judgments are valid for 10 years from the date of entry and may be extended for another 10 years. We find that many banks are putting those judgments "in their pocket" waiting for the homeowner to get back on his/her feet financially before pursuing the deficiency judgment. However, according to an article by Debra Cassens Weiss, published in the American Bar Association Journal, banks are beginning to increasingly pursue deficiency judgments. In fact, some collection firms are now buying those judgments from the banks for pennies on the dollar just to have an opportunity to collect money from the homeowner in future years.
Question: What are the tax implications of a foreclosure sale or short sale?
Answer: Under the Internal Revenue Code, a foreclosure sale is no different than any other sale and may result in the imposition of capital gains. However, for the years 2007 through 2012, the Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their personal residence. Debt reduced through mortgage restructuring as well as mortgage debt forgiven in connection with a foreclosure qualifies for this relief. Up to $2 million of forgiven debt is available for this exclusion. If your situation fits this category, we encourage you to secure a copy of Publication 4681 from www.irs.gov/ and seek the advice of an attorney or tax accountant in order to assist you in making sure that you comply with the law.
Question: What effect will a foreclosure or short sale have on my "credit score?"
Answer: Your credit score is based upon many components. If you have fallen behind in your mortgage payments, then your rating has already suffered. Any resolution of any mortgage loan, other than payment in full, will negatively impact your score. An experienced attorney can assist you in minimizing the effect of a negative credit event as well as the length of time that the event will effect your credit.
In any situation where a home is being sold as a short sale or as the result of a foreclosure, there are numerous decisions which need to be made that will have a significant impact on your financial future. For example, is it better to have a debt forgiven by a bank (and thereby incur potential tax ramifications) or is it better to still owe the bank money (and risk having your assets seized in the future after your finances improve)? Is it better to discharge a deficiency judgment now through bankruptcy (thereby affecting your credit rating) or wait to see if the bank tries to collect the debt in the future? Because the choice that the homeowner makes in connection with the many options available at the time of a foreclosure or short sale may impact the person for 20 or more years into the future, experienced legal advice is always warranted. We would be happy to assist you if you are facing these choices.