LEGAL "Q AND A"

Stephanie M. Weaver, Board Counsel

LEGAL CORNER

WARNING:  TAX CONSEQUENCES OF SHORT SALES AND FORECLOSURES

 February 1, 2008

Because the slowdown in the real estate industry has definitely hit Connecticut, as recent statistics have shown, I thought it would be important to discuss the unexpected tax consequences of short sales.

Most real estate agents and brokers have now participated in trying to get a sale approved by a mortgage company when the net proceeds are not sufficient to pay off the debt.  To get those sales approved, a borrower must make application, and documents must be submitted from the law office representing the seller which sets forth the expected expenses of the sale, as well as certain documents from the seller.  Close coordination between Seller, Buyer, the mortgage company, and the attorneys involved in the transaction are essential to get a short sale approved.  The real estate professional often times acts as the conduit, coordinator, and yes, task master to ensure that these documents and discussions happen in a timely fashion.  It becomes an unexpected effort for agents and brokers, but it forms an essential income stream in a down market, because when it is successful, commissions are paid! 

The short sale is often preferable for a seller/borrower, as it avoids foreclosure court and the costs associated with that, as well as perhaps fetching a sales price that is higher than that bid at a distress sale ordered by our court system.   

The consequences of a short sale, however, should be considered.  There are no deductions available for taking a loss on the sale of one’s primary residence. It is considered a nondeductible, personal expense.  Further, if the homeowner goes on to purchase another home and sells it later for a taxable profit, the previous loss cannot be used to offset it. 

If the Lender approves a short sale but refuses to write off the remaining debt, the Borrower continues to be responsible for the remaining debt, but payments are not able to be written off.   

Another potential pitfall for short sales are in those instances where previous to the short sale a borrower has refinanced based upon an appraisal that was far above the eventual short sale price.  If the Borrower sells below his/her basis in the property, and the Bank does not pursue the Borrower, there is a taxable capital gain, covered by the $250,000 exclusion, for the difference between Borrower’s basis and the sales price, but there may be further debt forgiveness equal to the difference between the mortgage amount and the amount the house sells at, NOT covered by the $250,000 exclusion.  This concept is harder to grasp.  

When a Lender forecloses on a property, and sells it for less than the Borrower’s debt, and does not pursue Borrower for the difference, it is reported as a cancelled debt.  That cancelled debt is reported as taxable income, but most Borrowers are shocked to receive a 1099 in January the next year!  It is taxed as ordinary income in the Borrower’s tax bracket, between 10 and 35 percent.  There are few exceptions to this, and Borrowers should be directed to an accountant when faced with the possibility of these events.  If the property sells at a foreclosure sale and it is more than the borrower’s basis, there is a taxable capital gain, which may be excluded if it is the Borrower’s principal residence at exclusion levels of $250,000 for a single, $500,000 for a married couple.  It becomes a taxable gain over Borrower’s basis in the property if it is not a principal residence. 

Since some of our Board’s real estate agents and brokers are also investors in the real estate market, these considerations are important for those of you that get caught in our current down-spiral, which I hope will be of short duration!  Please talk to your accountant in the event you are facing these tough choices, and urge your clients to do the same. 

LEGAL SEMINAR FOR BOARD COUNSEL

SEPTEMBER 2007

With the cooler days, we are all getting back into our busy work schedules.  I thought it would be useful to highlight some recent questions, changes in state law, and recent court decisions with respect to the real estate field. 

Clarification with respect to Oral offers on Real Estate:  For many of you that have been in the real estate field for some time, I’m sure you have been told that we have a law in Connecticut that says real estate contracts are not binding unless, among other things, they are in writing.  This is true, and the specific law that directs our actions is known as the Statute of Frauds.  However, we also have the law of agency that governs our behavior and duties as real estate agents and brokers.  As agents of the Seller, whether the listing or the selling agent, our business is often conducted over the phone.  It also happens in the driveways in front of houses, and other areas where there is no easy access to paper and signatures.  The law of agency requires that any oral offers or counteroffers be communicated to the Seller- whether or not they are in writing.  To be sure, it does not become a binding contract until it is written up and signed by both parties.  The law of agency, however, governs the conduct of the parties before that happens and requires the communication of all offers, written and verbal.   

Real Property (and other types of Property) and Minors:  Some important changes were made to the Uniform Transfers to Minors Act with respect to minors that may not, shall we say, be able to handle the responsibility of real estate or property when they are supposed to receive it.  A trustee may now turn over the property to a trust before the minor turns twenty-one for management, and must disperse said funds if the minor was supposed to receive it at age 21, at age 25.  For a full reading, please look at Senate Bill 1047, which takes effect October 1, 2007.   

Planning and Zoning:  To be clear that there was no choice of forum on appeals from the planning and zoning commission, the Supreme Court in Jewett City Savings Bank v. Town of Franklin held that if zoning regulations required an appeal of a zoning decision to the zoning board of appeals, a party could not sidestep that requirement and go directly to an appeal to Superior Court.  Not liking that decision, Public Act 07-60 now provides that an appeal of a special permit or special exception may be brought directly to Superior Court, notwithstanding any right to appeal to the ZBA.   

Title Insurance:  With title insurance being a requirement in almost every closing these days, it is a large source of business for local attorneys.  A measure was defeated which would have allowed insurance producers to sell this insurance directly.  The argument which defeated the bill was that it would have placed persons not knowledgeable about real property law and legal title concepts into the role of selling protective title insurance, in essence, opining on the necessity or non-necessity of such insurance and thus engaging in the practice of law.   

Delays in Mortgage Pay-off Letters:  For those of you who have had closings delayed because of lenders not providing pay off statements, especially on properties facing the looming abyss of foreclosure, Public Act 07-210 was passed this year, which allows attorneys to secure pay off information without the signature of the borrowers, and that mortgagees must provide the pay off amounts within 10 days of receipt of such request.  Failure to do so suspends interest from accruing on the loan until such information is provided.  Further, no fee may be charged to provide such information unless it is requested to be provided on an expedited basis.   

Power and the Condominium Association:  A small footnote in the scheme of important legislation, but of immense importance to those who deal with condominium associations and board control of rules and regulations, the Connecticut Supreme Court in Waterbury v. Northbook Condominium Association took a broad view of the power delegated to a condominium board by permitting the board to regulate the length of leashes.  Sometimes, single-unit home ownership looks particularly appealing!