While some states are now passing legislation that favors lenders, at the same time there are tantalizing federal and state tax benefits being offered to distressed homeowners who are facing foreclosure or considering short-selling.
Because of this situation, accountants need to have a deep understanding of their client's financial condition and engage in a careful analysis of all options available to distressed client homeowners who are considering short-selling or foreclosure for their principal residences.
As in all engagements, CPAs must exercise caution when giving advice - especially about such an important personal decision as to accept foreclosure or short-sell a primary residence. As always, written documentation and verbal reinforcement are keys to managing your risk as an accountant.
Following are a few points to keep in mind as you discuss the options and tax impacts of a short sale, foreclosure, mortgage restructuring, or bankruptcy with your clients:
Analyze your client and match their needs with the right debt-relief plan. Your client has numerous options for debt relief. From short-selling, to foreclosure, mortgage restructuring and bankruptcy, each option has different liabilities and tax benefits from which to create a positive plan for emergence from financial stress.
Understand the Federal Mortgage Forgiveness Debt Relief Act. Thoroughly understand this legislation and its extension periods, as well as the conforming legislation and its extension periods in your own state. Generally, the federal act and its state correlates allow those whose mortgage debt has been forgiven to exclude the amount forgiven as income for tax purposes.
Know the rights of banks in short-sale agreements. Banks often reserve the right in short-sale agreements to claim a deficiency (the difference between the amount owed on the mortgage and the market value of the home) from the borrower. Most at risk for this type of bank collection are homeowners who have previously borrowed against the value of their principal residences. Also at risk are homeowners who earn steady income from a W-2 employer. Lenders have an incentive to recoup as much as they can, and they do tend to exercise this claim on borrowers with steady earnings.
Be able to help your client understand the impact on their credit. Any negative information on a client's credit may appear on a credit report for up to seven years, but it could be a much shorter time. There are many actions a mortgage-holder in default can take to improve their credit more rapidly. For example, your client can order their credit reports and dispute any inaccurate or time-lapsed negative entries. There are many credit repair organizations and Web sites that can supply the information you and your client need.
Consider the option of bankruptcy. Foreclosure and short-selling aren't your client's only options. Clients may also opt for bankruptcy in order to keep their homes and avoid foreclosure. Under Chapter 7 or Chapter 13, a mortgage-holder has the right to keep their home if they can continue to make timely mortgage payments. In the case of a client with a tight revenue situation, freeing the money to be used for a mortgage and other basic payments can be a valid option. On the other hand, Chapter 7 bankruptcy carries a 10-year negative reporting period. If your client's home is worth half of what they owe, that might be cause for opting for a short-sale, which carries a two-year negative reporting timeframe.
Know what your client can retain from their property following foreclosure. There are other details that are helpful to know as well, particularly if your client has not retained an attorney. Some of these are: what a client can keep from their foreclosed property; whether clients in foreclosure are on the hook for homeowners' association fees; and whether landlords must inform tenants about foreclosure proceedings.
Counsel your clients carefully on other consequences and benefits, including property tax, and exclusions. Debt forgiven on second homes, rental property, business property, credit cards and car loans does not qualify for tax relief under the Federal Mortgage Forgiveness Debt Relief Act. Also, be sure to understand local and state rules relative to property tax exposure, and factor those into your analysis.
Statistics show that in times of financial stress, fraud and other forms of client malfeasance occur more frequently than in good economic times. From a risk management perspective, that's cause for CPAs to be extremely diligent in knowing their clients.
Acquire a solid understanding of the rapidly changing tax landscape, as well as the benefits and risks to your clients who are considering a short sale, foreclosure, mortgage restructuring or bankruptcy. This is both helpful to your client and a legal defense for you. If you've done your homework, then give your best advice and be sure to document all communications between yourself and debt-burdened clients. AT
Anthony Cooper, JD, is a tax analyst with Camico Mutual Insurance Co. (www.camico.com) providing policyholders with information regarding corporate income, gift and estate tax issues.
