Home Short Sales Deficiency Judgments and Tax Liability

Deficiency Judgment and Tax Liability Attorneys

Deficiency Judgments and Tax Liability

Buying a home can be seen as an opportunity and an investment, but also a gamble. An unpredicted downturn in the economy or housing market can leave a homeowner owing more money on their home than it is currently worth. A bad economy can also cause the homeowner to have difficulty keeping up with their house payments. This can lead to the struggling homeowner’s lender foreclosing on their property. If you are in danger of foreclosure, it is vital that you speak to an experienced San Fernando Valley foreclosure attorney. The legal team at Nader & Berneman has spent more than two decades counseling homeowners who have fallen on hard times. Call them today for a free case evaluation, at (800) 568-0707.

Short Sale and Deficiency Judgments

One way to avoid foreclosure is to sell your house at the current market rate, even though it is less than what you bought it for. This is called a "short sale." Here is an example: Five years ago, you bought your home for $500K. You made a $50K cash down payment and took out a mortgage for $450K. The market then collapsed, and today your house is valued at only $250K. Unfortunately, you still have $400K left to pay on your mortgage. If you were to short sell the house for its current market value, you would be leaving the lender with a deficiency of $150K. Sometimes, when a house is not devalued very much, a lender will encourage a short sale and write off their loss. Other times, a lender will go to court and get a deficiency judgment against the borrower. In this case, a lender could seek a deficiency judgment against you for $150K.

Deficiency Waiver

To avoid a deficiency judgment against yourself, it is important to negotiate an agreement with your lender before trying to short sell your house. What you want from the lender is a signed "Deficiency Waiver," freeing you from being responsible for paying back your deficiency. Larger banks are more likely to grant deficiency waivers to borrowers, because it’s easier for them to absorb the cost. Smaller banks are more likely to pursue deficiency judgments. If you are considering short selling your home, consult an experienced attorney first.

Tax Liability

Even if you get a deficiency waiver from your lender, that doesn’t mean you’re free and clear. When your lender grants you a deficiency waiver, they report that to the IRS who counts it as income paid to you. So, you may end up owing taxes on the amount of the deficiency waiver. In general, there are three ways to avoid tax liability from a deficiency waiver:

  • The Mortgage Forgiveness Debt Relief Act of 2007 lets you exclude income from a deficiency waiver if it is from your primary residence. However, this only applies to deficiency waiver income from the years 2007 through 2014.
  • If your liabilities outweigh your assets, the IRS will consider you insolvent, and therefore not responsible for taxes on a deficiency waiver.
  • Filing for Chapter 7 bankruptcy will get all of your debts forgiven, and debts forgiven through Chapter 7 are not taxable.

If you’re a homeowner who’s found yourself in a foreclosure situation, you need the advice and representation of a knowledgeable foreclosure law firm. The attorneys at the Encino offices of Nader & Berneman have been helping Southern California homeowners just like you for over 20 years. Call us today, at (800) 568-0707 for a free consultation.

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