CALIFORNIA REAL ESTATE PRIMER – 1031 Tax-Deferred Exchanges

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DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

What Is A 1031 Tax-Deferred Exchange?

“1031” refers to Internal Revenue Code section 1031 which details a method of transferring the equity from one real property into one or more like-kind properties without incurring the tax burden associated with the gain on the investment.

A common misconception is that a 1031 trade is tax free, but this isn’t true. 1031 exchanges are not tax exempt, they are tax deferred. Even so, if performed correctly 1031 exchanges can provide considerable benefits by allowing taxes to be paid by tomorrow’s dollars instead of today’s dollars. (Tomorrow’s dollars are usually cheaper than today’s dollars.)

A properly executed 1031 exchange can result is significant savings in terms of today’s dollars. For example, in a given exchange the potential tax burden which might be deferred is seen below: (note: the rates cited are subject to change)

15.0 % Long Term Federal Capital Gains

+ 9.2 % California State Tax

= 24.2 % Tax Deferral

Plus 25 % Federal Depreciation Recapture, and potential 26 % Federal Alternative Minimum Tax

 

Types of 1031 Exchanges

There are a number of different types of 1031 exchanges which are recognized:

(1) Simultaneous Exchange – When an exchange between the relinquished property and replacement property occurs concurrently.

(2) Delayed (“Starker”) Exchange – The delayed exchange is the most common of all exchanges. Once a the relinquished property is sold, the delayed exchange allows a property owner a set deadline to identify and close on the replacement property while maintaining the ability to continue deferring any capital gains. Just the calculation of the correct deadline can be a complex matter involving not only the deadlines stated in the code, but also a calculation based on the taxpayer’s filing date for the tax year in which the relinquished property is transferred.

(3) Build-To-Suit – This exchange allows the exchanger to construct a new replacement property or renovate an existing property. (Note: Renovations after the owner takes title are considered “goods and services” and will taxed as boot.)

(4) Reverse Exchange – The opposite of the delayed (Starker) exchange, a reverse exchange occurs when an investor identifies and closes on a replacement property prior to the sale of the relinquished property.

 

Who Can Effectuate A 1031 Exchange

A third party must act as a qualified intermediary to accommodate the exchange. (The qualified intermediary is known as an Accommodator or Facilitator.) Since the facilitator may be holding significant funds on your behalf. It behooves you to inquire about such things as errors and omissions insurance, bonding, and interest etc. Remember, you’re looking for safety, as well as, experience. It’s not unreasonable to ask for references from past clients.

 

1031 Exchange Requirements

(1) “Like-Kind” Exchange – To be considered “like-kind” the relinquished property and the replacement property must both comply with the definition of investment property. The general rule is that real estate is “like-kind” to all other real estate. Provided like-kind property is initially acquired and held for either business or investment purposes. (Held for productive use in a trade or business, or property that is held for investment.)

Examples of “like-kind” exchanges include:

Raw land for commercial property

Residential rental for tenants in common interest

Single-family rental for multi-family rental

(Note: The qualified intermediary or facilitator and/or your accountant or tax attorney must be consulted to be sure the exchange will qualify.  For example, a partnership may exchange property for other property of “like-Kind”, but IRC section 1031(a)(2)(D) specifically prohibits exchanges of partnership interests.  The reason is partnership interests are considered to by personal property which isn’t “like-kind” property with real estate. )

(2) The replacement property or properties must be of equal or greater value than the relinquished property.

(3) The Exchanger must reinvest all net equity in the replacement properties.

(4) The exchange must result in equal or greater debt.

(5) Retain a Qualified Intermediary (Facilitator) – To effect a 1031 exchange and defer the capital gains liability due, you must not take possession of the proceeds from a sale.

(6) 45-Day Rule – The exchanger must identify the potential replacement property or properties within the first 45 days of the 180 exchange period. Once you have closed your relinquished property and placed your proceeds with your Accommodator, the 45 day clock starts ticking to identify a replacement property.

(7) 180-Day Rule – The Exchanger must acquire the replacement property or properties either within 180 days or the date when the Exchanger must file the tax return (including extensions) for the year of the transfer of the relinquished property, whichever occurs first.

You may choose among 3 types of identifications:

3 Property Rule (most common): The Exchanger may identify up to three properties of any value.

200% Rule: The Exchanger may identify more than properties if the total fair market value of what is identified does not exceed 200% of the fair market value of the relinquished property.

95% Exception: If the Exchanger identifies properties in excess of Rule 1 and Rule 2, then the Exchanger must acquire 95% of the value of all properties identified.

Important Notes:

There is no extension of deadlines for Saturdays, Sundays or Holidays.

The time limits begin to run on the day the Exchanger transfers the relinquished property to the buyer.

The “Date of Transfer” will be the date of recording or transfer of the benefits and burdens of ownership, whichever occurs first.

As you can see, sections 1031 Tax Deferred Exchanges are not for the faint hearted. Not only are the rules less than clear they are subject to change. So, remember, always consult the appropriate, legal, tax and financial advisors and retain the services of an experienced facilitator.

This article is intended as an overview only, and should not be construed as legal, financial, or tax advice. Consult your legal and/or tax professional.

 

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CALIFORNIA REAL ESTATE PRIMER – Reduce Your California Property Tax

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DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

Reduce Your California Property Taxes

If you’re a home owner in California it may have occurred to you that your home is worth less now than the day you purchased it. If so, the next thought which will occur to you is why the devil are you paying property tax based on a market value which doesn’t exist any more?

Well, if you live in California you might be able to find some relief in something called an Informal Assessment Review.

California Revenue and Taxation Code

You might want to take a look at Section 51 of the California Revenue and Taxation Code. This particular code section provides that the assessed value of any real property (located in California) shall not exceed that property’s market value on the January 1 lien date.

This means that if your property’s market value on January 1 is less than its assessed value, as it appeared on the previous annual assessment roll, then you may be entitled to an assessment review!

So if your home’s market value has fallen below what you paid for the property it may be worth your while to obtain a form called a “Request For Informal Assessment Review,” from your county assessor’s office. In Orange County the Assessor’s phone number is (714) 834-2727.

If you do not agree with the roll value resulting from the informal review, you may file an Assessment Appeal form with the Office of the Clerk of the Board of Supervisors from July 2 through September 15. Assessment appeal forms can be obtained from your local library, the internet, or at the Clerk of the Board, Hall of Administration, 333 W. Santa Ana Blvd., Room 101, Santa Ana, CA 92701, (714) 834-2331.

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CALIFORNIA REAL ESTATE PRIMER – Transfer Your Property Tax Base Year To Your New Home

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DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

 

Transfer Your Property Tax Base Year Value New Home

Have you ever thought to yourself, “Gee it would be nice to sell the old house and get into a nice new one, but if I do I’ll have to pay property tax on the new purchase price.” Well, goods news. That may not necessarily be the case. If you meet the qualifications, California Propositions 13, 60 and 90 might just solve your dilemma.

 Proposition 13

Under Proposition 13 the value of a home, for property tax purposes, is reassessed to the new market level (the new purchase price) whenever a change in ownership occurs. This usually results in higher property taxes. (It is possible to get an informal assessment review and reduce your property tax basis, but that’s another story.)

 Proposition 60

Proposition 60 allows a transfer of base-year value of the principal residence sold of a senior citizen (55 and older) to a replacement dwelling of equal or lesser value within the same county.

Proposition 90

Proposition 90, enacted in California in November of 1988, provides an avenue for property tax relief to owners 55, and older, who sell their principal residence and purchase a replacement home of equal or lesser value in another county.

The County Assessors will require a copy of the tax bill from the other county and a copy of the applicant’s birth certificate to be included with the application. Also include a copy of the grant deed for the new purchase and a copy of the closing statements of both sale and purchase.

SUMMARY OF ELIGIBILITY REQUIREMENTS

The seller of the original residence, or a spouse residing with the seller, must be at least 55 years of age, as of the date that the original property is transferred.

The replacement property must be of equal or lesser “current market value” than the original.

The tax base year of the original property cannot be transferred to the replacement dwelling until the original property is sold.

The replacement property must be purchased or newly constructed within two years (before or after) of the sale of the original property.

The owner must file an application within three years following the purchase date or new construction completion date of the replacement property.

This is a one-time only filing. Proposition 60/90 relief cannot be granted if the claimant, or spouse, was granted relief in the past.

Proposition 60/90 relief includes, but is not limited to: single family residences, condominiums, units in planned unit developments, cooperative housing, corporation units or lots, community apartment units, mobile homes subject to local real property tax, and owner’s living premises which are a portion of a larger structure.

The taxpayer is not eligible for the tax relief until they actually own AND occupy and the replacement dwelling as their principle residence.

It is essential that you call the co-operating County in question, to verify that they are currently accepting the value transfer under Proposition 90, and what their requirements are. If you have any questions, the property tax office in Sacramento for all counties in California may be reached at (916) 445-4982.

Alameda (415) 272-3755 Ventura (805) 654-2181 Santa Clara (408) 299-4347 Kern (805) 861-2311 Modoc (916) 233-3939 San Diego (619) 531-5507 Los Angeles (213) 974-3101 Orange (714) 834-2746 San Mateo (415) 363-4500

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CALIFORNIA REAL ESTATE PRIMER – Preserve Your Prop 13 Base Year Value For Your Children

 

DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

Preserve Your California Prop 13 Base Year Value For Your Children And Grandchildren

In June of 1978, Proposition 13 passed in California and established base years for all real estate properties in the state. For people who owned property before March 1, 1975 the base year was established as of that date. Thereafter, as properties changed ownership the value at the time of the transfer was adopted as the new base year.

On average, property values have increased over time and each new buyer who acquires real estate in California understands they may have to pay more for property taxes than the previous owner.

So far, so good, except children and grandchildren who inherited real property were treated as new owners because by law the inheritance was considered a change in ownership causing the parents/grandparents lower base year value to disappear. As a result, the property tax could jump to 2 or 3 times its previous level.  This type of uannounced tax increase could be quite a surprise to the new owners.

The unintended result was a dampening effect on the continuing family ownership of real estate in California.  Children and/or Grandchildren inheriting the property many times found themselves unable to pay the new property taxes and as a result were forced to sell the property.

To counter this effect, Propositions 58 and 193 were passed in November of 1986 and March of 1996, respectively. The details of these laws can be found in Section 63.1 of the Revenue & Taxation Code.

In general, transfers of real property between parents and children and vice versa, as well as transfers from grandparents to grandchildren are excluded from reassessment. Note that transfers from grandchildren to grandparents are not excluded, and in the case of transfers from grandparents to grandchild, the parents of the grandchild must be deceased as of the date of purchase or transfer.

“Children” are considered to be the natural children, stepchildren, sons-in-law and daughters-in-law, and children adopted before the age of 18. The same requirements apply to grandchildren, step-grandchildren, and grandchildren-in-law.

Principal residences are excluded from reassessment, as well as, an additional $1,000,000 of the seller’s or decedent’s other real property. An exception to the principal residence exclusion exists for grandchildren who have previously received a principal resident (possibly from their parents). In such a case the grandparent’s principal residence will be treated at “other real property” and will be subject to the $1,000,000 limitation.

The $1,000,000 limitation is determined by the assessed value of the property immediately before transfer. The sales price or actual “current market value” does not affect the $1,000,000 limit. This limit is cummulative and once exceeded all later transfers will be reassessed except for the principal residence.

Happily, the $1,000,000 exclusion is a separate limit for each parent giving the community property of married parents a $2,000,000 limit. For grandchildren, the limit would be $1,000,000 from the father’s side (including grandparents) and $1,000,000 from the mother’s side (including grandparents).

The value of professional estate planning becomes obvious when it is realized that transfers by sale, gift, devise or inheritance all may qualify for the exclusion. Moreover, transfers to individuals and from trusts to individuals and from individuals to trusts may also qualify for the exclusion.

It falls to the person receiving the property to file a claim with the appropriate Assessor’s office within three years of the date of transfer and before any transfer to a third party or within six months after the date of mailing of a Notice of Assessed Value Change resulting from the transfer of the property, whichever is later. There are some exceptions to these deadlines. Once the claim is filed, the Assessor will determine if the transaction qualifies.

Any transfers you are planning should also be carefully considered in light of the relevant federal estate and gift tax laws, as well as the relevant state property tax laws.  Consult your tax advisor.

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CALIFORNIA REAL ESTATE PRIMER – Buyer’s Short Sale FAQs

DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

Over the course of time, we have fielded a lot of questions from buyers regarding short sales and some of those questions are more frequently asked than others. The questions below are the more frequent ones we’ve been asked:

 1. What is a short sale?

A short sale is the process by which homeowners can sell their home for less money than they actually owe on the mortgage(s). This is accomplished by providing proper documentation to the lender(s) to convince them to reduce the mortgage balance to allow the sale. If the sale is approved, the mortgages lender(s) will actually take a loss on the mortgage.

If a bank approves the discount of a mortgage, the home can be sold for a price lower than the total debt on the property without the seller having to come up with cash to cover the shortfall. The mortgage is satisfied and any foreclosure process stops.

2. Why would a bank or mortgage lender want to cooperate with a short sale?

A common saying is that banks are in the business of lending money and do not want to own real estate. While this is a little misleading, it is essentially true. When banks foreclose on a property it is a long and expensive process and generally means holding the property in their inventory as a non-performing asset. Banks have a limit to the amount of non-performing assets they want to hold. Once this limit is exceeded, they have strong incentives to get rid of the properties at discount prices.

For a lender, agreeing to a short sale avoids many of the costs associated with the foreclosure process. Attorney’s fees, delays from borrower bankruptcies, damage to the property, costs associated with resale, property tax, insurance, etc., must all be paid by the bank during a foreclosure. In a short sale scenario, the lender is able to cut its losses by getting rid of the property faster and at a lower cost.  The most important element in the lender’s decision process is whether or not the property is “underwater.”  If so, then it can’t be sold for an amount equal to or greater than the mortgage and a short sale may be a viable solution.

3. How does a bank determine the price it will accept on a short sale?

Every bank has a specific method of deciding how much they’ll accept on a short sale. Give me a call, Mikey Hall, at 949-887-1625 and I’ll explain it to you.

 4. Can I really get a deal on a short sale home?

Yes, you can, but not every short sale is a deal. You still have to do your research and estimate the current market value of the home. This is one of the areas where a knowledgeable real estate agent’s level of experience really pays off.

5. Who pays the real estate commissions on a short sale?

In a standard sale, commissions are subtracted from the seller’s funds and paid out of escrow to the Realtors. In a short sale, the seller has no funds in escrow which means the commissions end up being subtracted from the monies that would go to the lender. So, the lender ultimately is the one paying the entire sales commission.

6. Are short sales guaranteed to work?

No. All of the criteria must be met before a bank will even consider a short sale. Even then it isn’t easy to convince a bank that the market value of the home is lower than what they are owed.

Even if all the paperwork has been correctly completed it can take several weeks, or even months, only to be denied. If the lender does not approve the short sale, no transaction occurs. The Purchase Agreement becomes void and the listing continues. There are, however, ways to put a time limit on the lender’s time to issue approval.

In a rising market the delay in a short sale approval runs against the buyer for at least two reason 1) The buyer’s purchasing power decreases as prices increase; and, 2) there is no guarantee the lender will approve the sale and the delay may cause the buyer to be priced out of the market.

A falling market has just the opposite affect because a buyer’s purchasing power increases as prices decrease.

7. How long does a short sale take to complete?

From a few weeks to several months.

8. What if the house I want needs repairs.

Remember, when an owner short sells their home it’s because they are suffering a financial hardship. This means there is no money for repairs and as a buyer you can’t reasonably expect the seller to do much in the way of repairs. The good news is we have had some success convincing lenders to repair termite damage and to make reasonable repairs relating to safety. But, this type of cooperation is dependent on the expense involved, the nature of the repair, the purchase price being paid and the direction of the market.

9. What if the house I want has liens on it?

Liens can complicate matters because the owner will not have the financial capability of removing them. Depending on a number of factors, including the real estate market and the purchase price, the lender might be persuaded to clear the liens. Or, sometimes the lien holders themselves might be convinced to reduce their liens. A short sale in this circumstance will take substantially longer.

10. I’m an investor, can I buy a short sale?

The simple answer is yes, you can. However, there can be serious complications.

11. Can I buy the short sale for the price stated in the listing?

An experienced Realtor can quickly tell you whether or not the property is priced unusually low. If so, the home was probably intentionally priced that way to attract offers which might prompt the lender into letting the Realtor know what price it will accept. In which case, the chances of buying the property at the asking price may not be very good.

On the other hand , the property might be priced correctly and your chances of getting the property at the asking price will be reasonably good.

12. How long will it take to get bank approval of my offer?

The answer to this question depends on the expertise of the listing agent, which bank is involved, and how many loans are on the property. Once approval is obtained, the property can go into escrow which takes no longer than a standard sale.

14. Will the banks negotiate on price?

Yes.  More in down markets and less in up markets.

15. Do I get title to the property when I buy a short sale?

Yes, title is transferred to the buyer at the close of escrow, just like in a standard sale.

16. Are my property taxes based on the amount of debt that was on the short sale property?

No. In California, your property taxes are based on the purchase price of the home.

17. Can I transfer my property tax base to a sale short?

Possibly, depending on whether or not you meet the requirements. You might want to read our article entitled, “Transfer Your Property Tax Base Year Value To Your New Home“.

As the housing markets recover, fewer and fewer homes will be underwater until finally the short sale will again become an unusual event.

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CALIFORNIA REAL ESTATE PRIMER – Seller’s Short Sale FAQs

DISCLAIMER

This article is intended to be a general discussion only and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

 

Over time, we’ve collected the questions we are most frequently asked by clients who were considering the short sale of their property. Some of these questions are listed below.

1. What is a short sale?

A short sale is the process by which homeowners can sell their home for less money than they actually owe on their mortgage(s). This is accomplished by providing proper documentation to the lender(s) to convince them to reduce the mortgage balance to allow the sale. If the sale is approved, the mortgage lender(s) will actually take a loss on the mortgage.

If a bank approves the discount of a mortgage, the home can be sold for a price lower than the amount owed without the seller having to come up with cash to cover the shortfall. The mortgage is satisfied and any foreclosure process stops.

2. How does the bank decide what price to put on the property?

Every bank has a specific method of deciding how much they’ll accept on a short sale.

3. What type of situation is the short sale best for?

Most short sales are accomplished on properties heading toward foreclosure. This means the homeowner is at least 3 payments behind, and the foreclosure process has already begun. Recently however, more mortgages that are simply behind or “in default” are considered short sale candidates without actually being in foreclosure.

Next, the homeowner typically has no equity or negative equity in the home. In other words, the total balance owed to the lender is equal to, or greater than, the price at which the house can be sold.  If this weren’t the case, the lender would simply foreclose and sell the property itself.

Lastly, the homeowner must have some type of financial “hardship” which is preventing him from paying the mortgage.

4. Does a homeowner benefit from a short sale?

First and foremost, a short sale relieves the stress of being in foreclosure and it allows the homeowner to get rid of their big mortgage payment and move on with their lives. A short sale allows you to stop a foreclosure proceeding and get a fresh start. In our experience, this is the primary benefit to the homeowner.

On the credit side, a short sale is arguably the lessor of two evils. Having some late payments, and a foreclosure filed has already done damage to your credit.. However, a completed foreclosure generally does more damage than a short sale agreed to by a lender. Obviously, a bankruptcy significantly damages your credit score.

5. I’m an investor, can I short sale my rental property?

Yes, but remember the “hardship” element which must be present. For investors there may also be some income tax issues resulting from mortgage relief.  Remember to consult your tax advisor.

6. Does it matter what kind of loan I have?

Possibly. In some instances there is a potential risk of a deficiency judgement or a lawsuit on a loan contract, as opposed to judicial foreclosure. Give us a call and we can discuss the specifics of your situation.

7. I am in foreclosure. Is a short sale for me?

Each situation is different and must be evaluated individually. The important factors in relation to a short sale are:

  • Property in foreclosure or default
  • Personal financial hardship
  • Little or no equity in the property
  • At least 60 days until eviction date
  • The value of the home has declined below the loan amount

If you feel you fit into these criteria, give us a call and we can discuss your specific situation.

8. What if my mortgage is an FHA, HUD or VA mortgage?

Generally, short sales can be accomplished on all of these types of mortgages, though each one has different criteria.

9. What options other than a short sale might I have?

  • Cure your mortgage default (bring your payments current)
  • Attempt a loan modification that adjusts the terms of your existing loan (lower your payment)
  • Refinance your mortgage with another lender (lower your payment)
  • Try to sell your home through normal channels
  • Attempt to get your lender to accept a deed in lieu of a foreclosure
  • File for bankruptcy

10. What is “financial hardship” and why is it so important?

“Financial hardship” is a critical part of the short sale equation. No matter what you hear about banks “not being in the business of owning real estate”, they DO NOT easily give homeowners a break. They require GOOD REASON to give a discount for a short a sale.  Remember in most cases the bank has to answer to it investors and shareholders.

The only reason a lender will agree to a short sale is if they determine that a short sale will net them more money than proceeding with the foreclosure. Understanding the homeowner’s financial hardship plays a major role in the lender’s estimation of whether or not it will be paid in full for the mortgage. Quite simply, the lender may try to make the borrower pay the shortfall if there is no hardship.

Many homeowners try to use a short sale as a “get out of jail free” card to dump a poor investment. Lenders will not allow this, and it is a waste of time to try. If you are employed and have some assets, but you have simply lost value in your home and want to sell, you probably cannot short sale. If you are current on your mortgage, it’s possible but very difficult to short sale. Lenders need to see that you simply cannot pay them before they will agree to a short sale.

11. Who owns the house after a short sale?

The purchaser of the house is the owner after a short sale, just the same as in a normal sale. The mortgage lender is paid off and the previous homeowner moves to a different home.

 12. What do I do about my back property taxes when I do a short sale?

Just as in a normal home sale, the property taxes are the responsibility of the homeowner until the date the sale is closed. Then they become the responsibility of the buyer. If your property taxes have not been paid this will affect the negotiations between the buyer and the bank, so you must inform the buyer of the taxes owed.

13. Do you handle homes in my area?

Our focus is Orange County, California, however, we will consider listings in other areas of Southern California. In addition, we work with other short sale specialists in California and can often refer your case to local Real Estate Broker if we cannot help you.

14. Do you handle duplexes, apartment buildings, condos, or commercial property?

We handle residential properties of all types in virtually all price ranges, but we currently do not handle commercial properties.

15. My home is already listed for sale on the MLS, but isn’t selling; can I still do a short sale?

Yes, you can and it is relatively common. Some lenders even require that a house be listed for sale before approving a short sale in order to show that a discount is necessary.

16. My home is really nice, why is the short sale offer price so low?

Sellers often have an emotional attachment to their home and may feel a short sale offer is too low. It is important to remember a few things. First, the seller in a short sale can never receive any money in the transaction. It should therefore be of little concern what price is offered as long as the short sale is done. The only real exception is when the seller has tax liability concerns. (If there is tax liability, a lower sale price means a larger mortgage relief and a greater tax liability.) Otherwise, the price should not matter to the seller.

The important factor in a short sale is whether the lender will accept the price offered. Lenders often accept prices for short sales which may be surprising to normal homeowners or Realtors. Discounts of 30% are no longer uncommon. This happens for several reasons:

A. Sellers are often in denial about how bad the market really is for housing and therefore, how far the value has declined.

B. Lenders don’t like the foreclosure process any more than homeowners do (especially in California). Lenders incur substantial costs during a foreclosure process that can last more than 12 months. They have attorney fees, filing fees, publication fees, lost interest on the money that is tied up, property taxes, insurance, maintenance costs, as well as the potential for vandalism of a vacant home. This is all BEFORE having to try to sell the home as a bank-owned (REO) property and pay sales commissions. A short sale is a way to avoid some or all of these costs. If a lender calculates his cost of eviction at $50,000 for a house, they will often take a $40,000 loss on a short sale instead and be better off for having done so..

17. Who pays the real estate commissions on a short sale?

The commissions are paid from the funds the buyer places in escrow and because there is no equity in the house, the lender ultimately is the one paying the entire sales commission.

18. Are short sales guaranteed to work?

No. All of the criteria must be met before a bank will even consider a short sale. Even then, it isn’t easy to convince a bank that the market value of the home is lower than what they are owed.

Even if all the paperwork has been correctly completed it can take several weeks, or even months, only to be denied. If the lender does not approve the short sale, no transaction occurs. The Purchase Agreement becomes void and the listing continues.

Moreover, As the real estate market improves and the value of homes approaches and/or surpasses the amount owed it will become increasingly harder to obtain bank approval of a short sale.

19. How long does a short sale take?

A short sale can take 60 to 120 days or longer to complete. This is very important. The process is complicated and takes a lot of time. So to exercise the short sale option, you must act quickly. If you wait until one week before eviction, no one can help you with a short sale. It is simply impossible. DO NOT WAIT.

20. Why do I have to sign a Borrower’s Authorization?

The Borrower’s Authorization gives the lender permission to speak to your representative about your loan. That’s all it does, but it is necessary. An authorization must be filled out for each mortgage and for each Realtor or escrow officer authorized to act on your behalf.

21. I have heard that I could owe income taxes after a short sale, is this true?

Possibly, but it’s not that simple. There are a number of factors involved. For example, are you an investor or is the property your primary residence. Is the debt on the property “purchase money” or has the home been refinanced. If you’re an investor or if the property was refinanced are you insolvent? You can see how the matter can become complex in very short order. You must consult with an attorney or CPA on this issue.

When a lender writes off part of a loan (discounts it) the portion written off is the equivalent of a cash infusion to the owner. This “mortgage relief” is then reported as income to you by means of a 1099C form.

Even if you receive a 1099C and declare it as income, there is a good chance you will owe very little tax. This is because there is an IRS rule regarding “insolvency” which essentially says if you are insolvent (more liabilities than assets) at the time of the short sale, you don’t have to count the 1099C as income (instead you declare it, then obtain the exemption). There is an IRS form to complete to show you are insolvent. See the Internal Revenue Service website at www.irs.gov

In December of 2007, President Bush signed a new law into effect providing that for a specified period of time homeowners who satisfy certain requirements will not be taxed on mortgage relief. This bill is called, the “Homeowners Debt Forgiveness Act” and it may or may not apply to your situation.  This law was recently extended by President Obama up to December 31, 2013.

Again, you must consult your CPA or tax adviser.

20. I am behind on my mortgage payments, but not yet in foreclosure. Can I do a short sale?

Yes, as the market dropped, this happened with much greater regularity. Sometimes these are the most attractive short sales for both the buyer and the lender because the buyer can take advantage of the lender’s ability to avoid the vast majority of the costs of foreclosure.

In these cases, it is more important to have a very clear “hardship” story to explain to the lender why you are unable to make the payments.

21. My house needs a lot of repair; can I still do a short sale?

Yes, though it can make the process more difficult because the price must be lower to compensate for the repairs. The key is to show the bank’s appraiser all the work that needs to be done. Let me know in advance if this is the case with your home.

 22. I have more than 10% equity in my home – can I still do a short sale?

Probably not. However, you may be a candidate for a regular sale.

23. Other people are on the deed with me, but they don’t want to short sell. Can I still do a short sale?

No. All parties listed on the deed or mortgage must sign the short sale purchase agreement. There are no exceptions to this.

24. I have other liens (i.e. mechanics, IRS, court judgments) on my house; can I still do a short sale?

Yes, but it gets much more complicated and will take longer. If this is the case with your home, be sure to COMPLETELY list all liens you have. Each lien holder must be negotiated with individually. A short sale in this circumstance will take substantially longer.

25. I have property I inherited but I can’t afford the mortgage. Can I do a short sale?

Yes. You might also want to read our article, “Preserve Your Prop 13 Base Year For Your Children and Grandchildren“.

26. I have 2 or 3 mortgages on my house. Can I still do a short sale?

Yes, each mortgage or line of credit (HELOC) can be negotiated individually. It is important to know which mortgage filed the foreclosure or, if more than one are in foreclosure, which one filed first.

As the housing markets recover, fewer and fewer homes will be underwater until finally the short sale will again become an unusual event.

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CALIFORNIA REAL ESTATE PRIMER – Mortgage Forgiveness Debt Relief Act

001

DISCLAIMER

This article is intended to be a general discussion only, and should not be considered legal advice. Your use of it does not create an attorney-client relationship. Any liability that might arise from your use or reliance on this article or any of its links is expressly disclaimed. This blog is not legal, accounting or tax advice, is not to be acted on as such, it may not be current, and is subject to change without notice.

 

THE MORTGAGE FORGIVENESS DEBT RELIEF ACT

Recall that in our article, “Short Sales From The Seller’s Point of View,” we mentioned that the tax implications, of a short sale, for the borrower can be significant and are relatively complex. In very general terms, mortgage relief (i.e. a discount on the amount owed) is viewed as income, and will be reported to the IRS by the lender, and must be included in the borrower’s gross income. Having said that, on December 20, 2007 President Bush signed into law a measure giving tax breaks to homeowners who have mortgage debt forgiven on their family residence.  This law was part of the “Bush Tax Cuts” you may have heard about.  Note: The Bush Mortgage Debt Relief Act applies only to Federal income tax.  State income tax rules are set by each individual state and which state laws might apply to you is another subject best covered with your tax advisor.

With the passage of “The Mortgage Forgiveness Debt Relief Act of 2007“, a taxpayer did not have to pay federal income tax on debt forgiven for a loan secured by a qualified principal residence. This tax break applies to debts discharged from January 1, 2007 to December 31, 2009.  Qualified principal residence indebtedness is debt incurred in acquiring, constructing, or substantially improving the primary residence (up to $2 million for refinances).  The December 31, 2009 date was the date the law was initially set to expire.

Then in 2009, The Emergency Economic Stabilization Act of 2009 was passed.  This law extended the Bush exclusion of income for qualified debt relief.  This extension of the law was set to expire on December 31, 2012 and applied to discharges of qualified indebtedness occurring on, or after January 1, 2010.

On December 31, 2012 , at the 12th hour, congress passed yet another extension of the federal Mortgage Forgiveness Debt Relief Act through December 31, 2013.

Unfortunately, California did not renew its mortgage debt relief law.  In response, the California Association of Realtors has said it will sponsor California Senate Bill 30, introduced December 3, 2012, by Senator Calderon, D-Montebello.  If passed and signed into law, Senate Bill 30 will exempt mortgage debt forgiven on a principal residence as taxable income.  Until that happens however, it appears that in California mortgage debt relief from the short sale of a principal residence will be treated as taxable income.

On January 10, 2013, Senate Bill 30 was referred to the California Senate Governance and Finance Committee.

The following is a set of a set of IRS FAQs which may be helpful in understanding the nuances of the law:

What is the Mortgage Forgiveness Debt Relief Act of 2007?

The Mortgage Forgiveness Debt Relief Act of 2007 was enacted on December 20, 2007 (see News Release IR-2008-17). Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence.

“What does that mean?

Usually, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude certain cancelled debt on your principal residence from income.

“Does the Mortgage Forgiveness Debt Relief Act of 2007 apply to all forgiven or cancelled debts?

No, the Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.

“What about refinanced homes?

Debt used to refinance your home qualifies for this exclusion, but only up to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified.

“Does this provision apply for the 2007 tax year only?

It applies to qualified debt forgiven in 2007, 2008 or 2009.

“If the forgiven debt is excluded from income, do I have to report it on my tax return?

Yes. The amount of debt forgiven must be reported on Form 982 and the Form 982 must be attached to your tax return.

“Do I have to complete the entire Form 982?

Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Adjustment), is used for other purposes in addition to reporting the exclusion of forgiveness of qualified principal residence indebtedness. If you are using the form only to report the exclusion of forgiveness of qualified principal residence indebtedness as the result of foreclosure on your principal residence, you only need to complete lines 1e and 2. If you kept ownership of your home and modification of the terms of your mortgage resulted in the forgiveness of qualified principal residence indebtedness, complete lines 1e, 2, and 10b. Attach the Form 982 to your tax return.

“Where can I get this form?

You can download the form at IRS.gov, or call 1-800-829-3676. If you call to order, please allow 7-10 days for delivery.

“How do I know or find out how much was forgiven?

Your lender should send a Form 1099-C, Cancellation of Debt, by January 31, 2008. The amount of debt forgiven or cancelled will be shown in box 2. If this debt is all qualified principal residence indebtedness, the amount shown in box 2 will generally be the amount that you enter on lines 2 and 10b, if applicable, on Form 982.

“Can I exclude debt forgiven on my second home, credit card or car loans?

Not under this provision. Only cancelled debt used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for this exclusion.

“If part of the forgiven debt doesn’t qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?

Yes. The forgiven debt may qualify under the “insolvency” exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982.

“Is there a limit on the amount of forgiven qualified principal residence indebtedness that can be excluded from income?

There is no dollar limit if the principal balance of the loan was less than $2 million ($1 million if married filing separately for the tax year) at the time the loan was forgiven. If the balance was greater, see the instructions to Form 982, page 4.

“Is there anything else I need to know before filing?

Yes. Because the Mortgage Forgiveness Debt Relief Act of 2007 was passed so late in the year, the software systems used by tax preparers and at the Internal Revenue Service need to be updated to accept the revised Form 982. The IRS expects to be able to process the new Form 982 electronically on March 3, 2008.”

Before a short sale is contemplated, it is strongly recommended that the borrower seek the advice of a professional tax advisor.

The information contained herein is deemed reliable, but must be independently verified.

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voice: 949-887-1625

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fax: 866-764-6325

DISCLAIMER

This article is intended to be a general discussion only, and should not be considered legal or real estate advice. Your use of it does not create either an attorney-client or broker-client relationship. Any liability that might arise from your use or reliance on this article, or any of its links, is expressly disclaimed. This blog is not legal, real estate, loan, accounting or tax advice, and is not to be acted on as such, it was outdated the moment it was written, and is subject to change without notice.  If you are dealing with a potential problem with your investment property you are advised to retain the appropriate licensed professional.