Law & Society

The real estate crisis reaches every strata of society, including financially stable individuals and companies. There is no one-size-fits-all approach, however, and affluent clients have unique concerns that have been largely over-looked by the media and governmental programs. This article discusses strategies for resolving mortgage problems for people who have good reason to worry about deficiency judgments, credit rating, and public image. August 2010

I am a Florida attorney whose firm focuses heavily on resolving problems with distressed properties. My associates and I have been defending foreclosures and facilitating loss mitigation right from the start of the economic downturn, and we have seen many interesting developments along the way. Just to name a few, we have seen courts reacting wildly to the incredible influx of foreclosure suits, governmental attempts to prod lenders into sharing responsibility for the situation, and homeowners running the full gamut of emotions.
What we are seeing more often in recent months are clients who have significant assets and six-figure incomes coming to realize they need to address their property issues. Almost invariably, investment properties have nowhere near the value of their loans and, more often than not, rental income is not sufficient to cover the mortgage payments. Successful people know how to read the writing on the wall and it seems their earlier moral misgivings, etc. are starting to take a back seat to business realities. Notwithstanding, they have certain concerns because they do have something to lose.


Deficiency Judgments

Essentially, when a property is foreclosed, sold via short sale, or surrendered through a deed-in-lieu-of-foreclosure, the lender has a statutory right to pursue a deficiency judgment against the borrower for the difference between the market value of the property and the amount of the loan. In 2009, it was very rare to see lenders exercise this right, probably, because they felt it would be throwing good money after bad to spend more money on attorneys only to end up with a judgment that could not be enforced. After all, many homeowners losing their properties were judgment-proof (i.e. no assets to attach and wages too low to garnish). Also, declaring Chapter 7 bankruptcy discharges deficiencies, and those homeowners not already planning to declare bankruptcy certain would if confronted with a large deficiency.

In 2010, so far, we are still not seeing lenders go after deficiency judgments, but we are out of the woods yet. The alternative to pursuing the deficiency is for the lender to take the loss and issue a Form 1099, which causes the deficient amount to be imputed against the homeowner as income for tax purposes unless some exception applies. The U.S. government has helped out in this area by passing the Mortgage Debt Relief Act, which protects homeowners against such tax implications if the deficiency is on the primary residence. Note, however, this does not apply to investment properties.

Accordingly, the prospect of a deficiency judgment is not such a big concern for the homeowner that is in dire financial straits. By contrast, it is a serious concern for financially stable homeowners, especially those for whom bankruptcy is not really an option.

For one thing, affluent homeowners are much more attractive targets for lenders considering a deficiency action. I do not pretend to fully understand the mind of the banking industry, so some of this is speculation. Still, it does stand to reason that a lender would be more inclined to pursue the deficiency where there is a real chance of collecting. Also, affluent homeowners tend to have investment properties, which are usually the ones for which they are seeking a solution. That means, even if our firm is able to prevent a deficiency action, the Mortgage Debt Relief Act will not obviate the tax implications. So, what is the answer?

First, you are still better off with the 1099 than with a deficiency judgment. I am not an accountant nor a tax attorney, so I will not go into some of the techniques they have for reducing or eliminating the tax implications of forgiven debt. Just know that there are some things that can be done even when the deficiency is on an investment property. In reality, even in a worst case scenario, where you have to pay taxes on the full amount of the deficiency, that is still only a fraction of what a deficiency judgment would cost. So, avoiding the deficiency judgment is definitely step one. How do we do that?

The short answer is, “Don't be a push-over.” Deficiency judgments do not happen automatically. The lender has to initiate an action and then deal with all the defenses, counter-arguments, etc. that an experienced foreclosure defense attorney will know how to present.

So, avoiding the deficiency judgment is definitely step one. How do we do that? The short answer is, “Don't be a push-over.”