by: attorney steven a. sokol halling + sokol llp 310-277-2080 / 818-222-4994 ssokol@hallingsokol.com...

By: Attorney Steven A. SokolHalling + Sokol LLP

310-277-2080 / 818-222-4994ssokol@hallingsokol.com

Real Estate in Troubled Times: Short Sales, Foreclosures,

Bankruptcy, Tax Effects

INTRODUCTION

Loans in TroubleThe Basics

Loans

Securing by “pledge” of property

Debtor protection

Rules to limit how creditor takes or sells pledged property

Loans

Securing by “pledge” of property

Debtor protection

Rules to limit how creditor takes or sells pledged property

Ancient conceptAncient concept

Often damaged, in need of repair

Vacant, not lived in for some time

May be unmarketable in present condition

Often damaged, in need of repair

Vacant, not lived in for some time

May be unmarketable in present condition

Condition of PropertiesCondition of Properties

Owner can sell to anyone at any time, up and until actual date of foreclosure sale

Home Equity Sales Contract rules may also apply (see below)

Owner can sell to anyone at any time, up and until actual date of foreclosure sale

Home Equity Sales Contract rules may also apply (see below)

Sale During ForeclosureSale During Foreclosure

Homeowner in Default

Slow economy – decrease Fed funds rate

Sound and profitable economy – inflation-threatened, raise Fed funds rate

Mortgage rates – increase/decrease in advance of actual adjustment by the Fed

Employment and personal income thrive between two extremes Mortgage interest rates higher

Home prices and rate of appreciation stabilize

Steady employment and increasing income Promote new home ownership for many Continued home ownership for most Ability to pay mortgage

Cyclic transitions affect personal households Fed steps in to assist improving economy Mortgage interest rates begin dropping

Loss of Household Income

Slow economy may result in reduced personal income “Two-income family” nation Loss of partial income difficulties Job loss devastating

Financial Mismanagement

Debt ratio affects ability to pay more than allowable minimum monthly payments

Home highly leveraged with little available equity

Poor payment discipline, even with ability to pay

History of Deeds-of-Trusts as California’s Preferred

Security Instrument

Loans secured by mortgage, not trust deeds Mortgages subject to California debtor

protection laws Trust deeds were not California lenders switched to using trust

deeds

California Supreme Court held: Debtor protection applied equally to

mortgages and trust deeds Trust deeds being used by then Lenders continued doing so

Types of Security Instruments

Trust deedMortgageInstallment land contract or contract of

sale Each must be recorded in county where

property located

Trust deed – most common California debt instrument Borrower or “Trustor” Lender or “Beneficiary” “Trustee” receives “bare legal title”

Power of sale to reconvey and foreclose

Mortgage – seldom used in California Lender or “Mortgagee” Borrower or “Mortgagor” New form gives trustee additional powers

Installment land contract or contract of sale Seller retains fee title until buyer performs

contractual obligations Buyer-vendee receives equitable title Recorded to protect against fraud or

bankruptcy Vendor recourse a “quiet title” action

RESTRUCTURING LOANS

Lender’s Desireto Avoid Foreclosure

Mortgagelender

Mortgagelender

Defaultingborrower

Defaultingborrower

Working to avoid

foreclosure and loss

possibility

Working to avoid

foreclosure and loss

possibility

Lender’s Evaluation Process to Assist the Borrower in Default

Cause or contribution to delinquency Reasonably beyond control of borrower Likelihood of resolution within reasonable time

period Access to additional funds Sufficient equity to pay off loan if sold Short-pay acceptable

Questionnaire and financial statement

Assistance Options Offered by the Lender

Temporary relief: Special forbearance Permanent modification of existing mortgage Combination of both options

Normal monthly payments over period of time

Past due amounts added to loan balance New and higher payments repaid over

remaining life of loan Due date extended until paid in full

Balloon payments of past due amounts Monthly payment same Monthly payment reduced for period of time

Interest only payment

Payment plan on arrears

Partial mortgage payments

Payment on moratorium

Interest only payment

Payment plan on arrears

Partial mortgage payments

Payment on moratorium

ForbearanceForbearance

Reduce interest rate

Change mortgage product type

Extend term of mortgage

Reduce interest rate

Change mortgage product type

Extend term of mortgage

Loan ModificationLoan Modification

MGIC Investment Corporation

Private Mortgage Insurance

Only Lender can make a claim

MGIC Investment Corporation

Private Mortgage Insurance

Only Lender can make a claim

Additional Player-Mortgage InsuranceAdditional Player-

Mortgage Insurance

Reported as “deed-in-lieu-foreclosure”

Less derogatory item on credit report

Reported as “deed-in-lieu-foreclosure”

Less derogatory item on credit report

Homeowner BenefitsHomeowner Benefits

Move sooner than if in foreclosure

Negative impact on credit report

Tax consequence

Move sooner than if in foreclosure

Negative impact on credit report

Tax consequence

Homeowner RisksHomeowner Risks

Save costs and time of foreclosure

Obtain property earlier to expedite resale

Save costs and time of foreclosure

Obtain property earlier to expedite resale

Lender BenefitsLender Benefits

Assume liability if secondary financing in place

Clouded title

Assume liability if secondary financing in place

Clouded title

Lender RisksLender Risks

SHORT PAYS

“Short-sale” – lender accepts less than full amount due from sale Homeowner already delinquent Comparison of short-pay loss to anticipated

foreclosure loss

Lender Agrees to AcceptLess than Amount Owed

Approaching a Short-Pay

Review/research borrower documents: Income documents Bank statements Financial statement or Fannie Mae 1003 loan

application form Recent credit report for all borrowers on loan Explanation letter and reason for request

Review/research lender documents: Competitive market analysis, or BPO Copy of listing agreement, Multiple Listing

Service “print-out” Purchase contract and escrow instructions, if

already sold Estimated settlement statement from escrow Current preliminary title report

Lender’s Decision-Making Process

Circumstances beyond homeowner controlSufficient financial reserves for short-sale

deficiencyReduction of fees chargedReduce or eliminate buyer concessionsBuyer sale price in relation to competitive

market analysis or BPO

Risks of a Short-Payto the Homeowner

Adversely affects credit reportTax consequencesRecorded junior loans cause difficulties

with senior lender

HOME EQUITY SALES CONTRACTS

Owner-occupied 1-4 residential property

Special requirements:

Name, business address, telephone number of purchaser

Address of residence in foreclosure

Owner-occupied 1-4 residential property

Special requirements:

Name, business address, telephone number of purchaser

Address of residence in foreclosure

Home Equity Sales ContractsHome Equity Sales Contracts

Total consideration given by purchaser

Complete description of terms of payment or other consideration

Time of possession

Terms of rental agreement

Total consideration given by purchaser

Complete description of terms of payment or other consideration

Time of possession

Terms of rental agreement

“NOTICE REQUIRED BY CALIFORNIA LAW UNTIL YOUR RIGHT TO CANCEL THIS CONTRACT HAS ENDED.

(NAME) OR ANYONE WORKING FOR (NAME) CANNOT ASK YOU TO SIGN OR HAVE YOU SIGN ANY DEED OR ANY OTHER DOCUMENT”

“NOTICE REQUIRED BY CALIFORNIA LAW UNTIL YOUR RIGHT TO CANCEL THIS CONTRACT HAS ENDED.

(NAME) OR ANYONE WORKING FOR (NAME) CANNOT ASK YOU TO SIGN OR HAVE YOU SIGN ANY DEED OR ANY OTHER DOCUMENT”

Notices required on contractsNotices required on contracts

Immediately above “cancellation notice”

“YOU MAY CANCEL THIS CONTRACT FOR THE SALE OF YOUR HOUSE WITHOUT ANY PENALTY OR OBLIGATION AT ANY TIME BEFORE (DATE AND TIME OF DAY). SEE THE ATTACHED NOTICE OF CANCELLATION FORM FOR AN EXPLANATION OF THIS RIGHT.”

“YOU MAY CANCEL THIS CONTRACT FOR THE SALE OF YOUR HOUSE WITHOUT ANY PENALTY OR OBLIGATION AT ANY TIME BEFORE (DATE AND TIME OF DAY). SEE THE ATTACHED NOTICE OF CANCELLATION FORM FOR AN EXPLANATION OF THIS RIGHT.”

Immediate proximity to space for seller’s signature

Rescission timeline:

Midnight of the 5th business day following day on which seller signs contract, or

8:00 a.m. on day scheduled for sale of property under power of sale in Deed of trust,

whichever occurs first

Rescission timeline:

Midnight of the 5th business day following day on which seller signs contract, or

8:00 a.m. on day scheduled for sale of property under power of sale in Deed of trust,

whichever occurs first

“TO CANCEL THIS TRANSACTION, PERSONALLY DELIVER A SIGNED AND DATED COPY OF THIS CANCELLATION NOTICE, OR SEND A TELEGRAM TO (NAME OF PURCHASER), AT (STREET ADDRESS OF PURCHASER’S PLACE OF BUSINESS) NOT LATER THAN (ENTER DATE AND TIME OF DAY). “I HEREBY CANCEL THIS TRANSACTION (DATE). (SELLER’S SIGNATURE)”

“TO CANCEL THIS TRANSACTION, PERSONALLY DELIVER A SIGNED AND DATED COPY OF THIS CANCELLATION NOTICE, OR SEND A TELEGRAM TO (NAME OF PURCHASER), AT (STREET ADDRESS OF PURCHASER’S PLACE OF BUSINESS) NOT LATER THAN (ENTER DATE AND TIME OF DAY). “I HEREBY CANCEL THIS TRANSACTION (DATE). (SELLER’S SIGNATURE)”

Attached to contract in duplicate, easily detachable

Seller may rescind up to 2 years after deed to buyer is recorded IF Seller was taken “unconscionable advantage” of by Buyer

If court action to enforce rescission right, prevailing party is entitled to costs of suit/reasonable attorneys’ fees

Seller may rescind up to 2 years after deed to buyer is recorded IF Seller was taken “unconscionable advantage” of by Buyer

If court action to enforce rescission right, prevailing party is entitled to costs of suit/reasonable attorneys’ fees

Two Year Right to CancelTwo Year Right to Cancel

Purchased for personal residence

Seller gives buyer deed in lieu of foreclosure of voluntary lien or encumbrance of record

Trustee transfer acting under power of sale in deed of trust or mortgage at foreclosure sale

Purchased for personal residence

Seller gives buyer deed in lieu of foreclosure of voluntary lien or encumbrance of record

Trustee transfer acting under power of sale in deed of trust or mortgage at foreclosure sale

ExceptionsExceptions

Sale is authorized by statute

Sale is by order or judgment of court

Sale is from/to spouse, blood relative, blood relative of spouse

Property other than 1-4 family residential

Not seller-occupied

Sale is authorized by statute

Sale is by order or judgment of court

Sale is from/to spouse, blood relative, blood relative of spouse

Property other than 1-4 family residential

Not seller-occupied

Broker’s Position“Purchaser representative” requirements as of

January 1, 1991 Must provide

Written proof of valid current California Real Estate Sales License and bond

Written statement of valid California Real Estate Sales License and bond, compliance with above

Failure to comply can render contract void and purchaser liable to seller for damages

Civil Code §1695-1695.17, 1691

Purchaser’s “Representative” -

“A person who in any manner solicits, induces, or causes a property owner to transfer title or solicits any member of the property owner’s family or household to induce or cause any property owner to transfer title to the residence in foreclosure to the equity purchaser.”

Civil Code §1695.15(b)

Finding information about foreclosure properties County Recorder’s Office Research services Local newspapers Classified ads

Home Equity Explanation and Agency Agreement (HEAA) 4/05

Notice of Default Purchase Agreement (NODPA) 1/06

Notice of Cancellationof Notice of

DefaultPurchase Agreement (HENC)

1/06

DEEDS-IN-LIEU-OF-FORECLOSURE

Deeds-in-Lieu-of-Foreclosure

Voluntary deed of from borrower to lender

No completed foreclosure by lender

FORECLOSURE PROCESS

The Borrower’s Default

Promise to perform required by trust deed is broken Monetary – failure to pay loan payment or

balance when due Non-monetary –

Failure to pay homeowner’s insurance or property taxes

Failure to maintain property Failure to pay senior lien holder

Notice of Delinquency

Loan delinquent for at least four monthsSent within 15 days after end of 4th

delinquent monthLoan secured by 1-4 unit residential

propertyCurrent Request for Notice of DelinquencyFirst-class mail or in person

Notice of Balloon Payment

If 1-4 family residential property, written notice 90-150 days before due date

Applies to both seller- and non-seller-carried financing

Notice of payment due required

Notice of Default

Occurs day after loan payment missed unless note contains grace period

Most lenders choose not to file until 2 or 3 payments missed

Options: Judicial foreclosure process through Superior

Court Action under power of sale provision of deed

of trust

Lender notifies Trustee to prepare and record NOD

Trustee prepares and records NOD Within 10 days of recording NOD, Trustee

mails copy to Trustor and persons who have recorded “Request for NOD”)

Within 30 days of recording NOD, Trustee mails copy to junior lien/interest holders having recorded interests in property

NOD must be mailed to each person Certified or registered mail, and Regular first class mail

Trustor can reinstate loan up to 5 days before Trustee’s sale

The Trustee’s Sale

Notice of Sale published within 3 months (89-92 days) following NOD recordation

Publication once a week for 3 weeks First publication at least 20 days before

Trustee’s Sale Trustee’s Sale 21+ days after Notice of Sale

published

Trustee’s right to reinstate loan up until 5 business days prior to sale date

25 days before Trustee’s Sale date, Trustee sends copy of NOS to IRS

25 days before Trustee’s Sale date, Trustee sends copy of NOS to State Controller

20 days before Trustee’s Sale date, Trustee posts copy of NOS on property

20 days before Trustee’s Sale date, Trustee posts copy of NOS in public place in city or county where property located

14 days prior to sale date, Trustee records NOS

5 business days prior to Trustee’s Sale, Trustor’s right to reinstate expires

Bidding opens

Type of funds required specified

Beneficiary lender makes 1st bid

Lender money deposit not required unless making overbid

Overbid of lender permitted

Bidding opens

Type of funds required specified

Beneficiary lender makes 1st bid

Lender money deposit not required unless making overbid

Overbid of lender permitted

Trustee’s Sale DateTrustee’s Sale Date

Property sold to highest bidder

IRS has 120 days after Trustee’s Sale to redeem property if lien recorded

Property sold to highest bidder

IRS has 120 days after Trustee’s Sale to redeem property if lien recorded

Trustee’s Sale DateTrustee’s Sale Date

90-150 days before balloon payment due Mail Notice of Balloon Payment, if required

starts 3 month [89-92] day period Record Notice of Default (NOD)

10 days or sooner after recording Mail NOD to Trustor and persons who recorded Request for Notice

30 days or sooner after recording Mail NOD to recorded junior lienholders, lessees, etc., who did not record Request

for Notice

25 days or more before Trustee’s Sale Mail Notice of Sale (NOS) to IRS and CA State Controller, if required

STARTTiming Requirement

Typical Trustee’s Sale Foreclosure TimelineTypical Trustee’s Sale Foreclosure Timeline

14 days or more before Trustee’s Sale Record NOS

5 business days before Trustee’s Sale Right to Reinstate Ends

Date in NOS or postponed date Trustee’s Sale is held

Varies Trustee’s Deed is delivered/recorded

120 days after Trustee’s SaleIRS redemption period ends (Trustor, junior

lienholders, lessees, etc., do not have redemption right after Trustee’s Sale

FINISH

1. Publish in newspaper of general circulation2. Post on property3. Post in public place in city/county4. Mail to Trustor and interested persons

21 days or more before Trustee’s Sale Publish, Post, and Mail NOS

Timing Requirement

Judicial Foreclosure

Lender’s Choice whether to use Trustee’s Sale or Judicial Foreclosure

Pursue collection of deficiency California law prohibits certain deficiency judgments Property sold at judicial foreclosure subject to Right of

Redemption

Defective Documents

Deficiency Judgment

Lender prohibited from pursuing: 1-4 unit family residence, borrower

occupied as residence Note and deed of trust seller financing California’s “One Form of Action” rule

Special environmental contamination exception

Guarantors and Deficiency Judgments

Not protected by anti-deficiency judgment laws

Can be sued for personal liability or deficiency judgment

Maximum Deficiency Judgment Allowed

Equal to amount by which total indebtedness owed to lender exceeds FMV of property on sale date

Borrower’s Right of Redemption(only Judicial Foreclosure)

Only exists for judicial foreclosure No post-foreclosure redemption if lender used

Trustee’s Sale OR if lender is prohibited from obtaining deficiency judgment against Borrower

If judicial foreclosure is used, redemption period: 3 months after sale if proceeds are sufficient to satisfy

indebtedness 1 year after sale if proceeds not sufficient to satisfy

indebtedness and lender obtains deficiency judgment (personal liability)

Justice Department Report on Scams

Fractional interest transfer scam.Serial filings by related debtorsVoluntary dismissals of Chapter 13 casesInvoluntary petition scamsPhony alias amendments to petitions

TAX EFFECTS

Tax Effect of Short Loan PayoffsFacts:

Mortgage balance = $900,000 FMV = $645,000 Selling costs = $45,000 Proceeds from sale = $600,000 Adjusted basis of property = $450,000

Tax effect: No gain if client insolvent at time of sale Tax disaster if client solvent at time of sale

Calculation of Gain from SaleSales price $ 645,000 Adjusted basis (450,000)Selling Costs (45,000)Capital Gain $ 150,000

Calculation of 1099 from MortgageBalance of Mortgage $ 900,000 Payoff:Sales Price 645,000 Selling Expense (45,000)Net Sales Price 600,000 1099 from Mortgage $ 300,000

Amount of TaxCapital gain $ 150,000 Maximum tax rate 15%Amount of tax $ 29,400 Ordinary income $ 300,000 Estimated tax rate 30%Estimated tax $ 90,000

Method of Conveyance Foreclosure VoluntaryType of Loan Recourse Non-Recourse Recourse Non-Recourse

Loan Balance

Proceeds

Sale Price

Basis

Gain or (Loss)

Amount Due Lender

Total Income

Sale Price =

$ 900,000

600,000

600,000

450,000

150,000

300,000

$ 450,000

FMV

$ 900,000

600,000

900,000

450,000

450,000

0

$ 450,000

>Debt or FMV

$ 900,000

600,000

600,000

450,000

150,000

300,000

$ 450,000

<Debt or FMV

$ 900,000

600,000

900,000

450,000

450,000

0

$ 450,000

Debt

BANKRUPTCY

Chapter 7 Chapter 11 Chapter 13 Automatic Stay Relief from Automatic Stay

CONCLUSION

By: Attorney Steven A. SokolHalling + Sokol LLP

310-277-2080 / 818-222-4994ssokol@hallingsokol.com

Real Estate in Troubled Times: Short Sales, Foreclosures,

Bankruptcy, Tax Effects