Tuesday, March 29, 2011

Taxes Are for Chumps! Underwater Investment Properties Don't Have to Get Soaked!

Last week there were grand articles decrying the fact that not only did GE, maybe one of the largest businesses in the world, not pay any US tax, it got a refund.  So, GE, according to the articles soaked the US government and tax payers alike. I studied U.S. International taxation at the University of Florida to learn how to do and assist companies like GE in accomplishing exactly that outcome.  No U.S. tax.  Is it right?, the rules make it okay.  Is it ethical?  Now that is a debate for philosophers and charlatans.  Suffice it to say, that the Tax Code written by your duly elected congressmen is rife with loop holes that would allow a behemoth like GE to walk through and even some that a small real estate investor can squeeze through too, if he, or she, knows where to look.  Its tight fit, but it acts like a squeegee so you don't get soaked.

I do some digging on AVVO.com an attorney locating website that allows attorneys to answer questions and bump up their rankings.  There was a question presented by a woman, who prior to marrying her husband, had purchased a home to use as a rental income property.  She had the home up for short sale, which implies that it was underwater or upside down, and thus it was also possible it was in danger of foreclosure.  Right up my alley, right?  Her question was, "Is there something other than "insolvency" that I can claim so I don't have to pay "COD" income on the forgiven debt?"

First, let's define a few things.  COD or cancellation of debt, or discharge of indebtedness, income arises under Internal Revenue Code Section 61(a)(12) and is basically the theory that when you take out a loan, you have cash (even though you probably never saw the cash) and that when the loan is forgiven without paying for it, the cash you supposedly had is now income.  Next, insolvency is not bankruptcy insolvency, because the IRS doesn't allow for exemptions like a homestead.  Insolvency is basically you total up all your assets and subtract all your liablities, and if you come out with a negative number, you are insolvent.

The issue the woman was struggling with is that her other assets probably are fairing better than her rental property but she doesn't want to liquidate performing assets to pay the government for what she likely has as a loss on her rental property. Essentially, she isn't insolvent, does she still have to pay the tax.

The first poster to this woman's question went on and on about mortgage forgiveness act of 2007 and was really far off, because he never once looked at IRC section 108(a)(1)(D) which allows for the exclusion of qualified real property business indebtedness income, a fancy way of saying a mortgage on a rental property that is forgiven.

That section, for real estate investor who haven't put their property inside a C-Corporation, and anyone that puts real property in a corporation should shoot their adviser (can I say that in light of Arizona?), is like gold.  Its not perfect, because there are some things to be aware of, but essentially, the investor can exclude from gross income, the amount of COD income that is attributed to the house being underwater.  The investor must subtract that amount from the basis of depreciable property, so the investor will defer the tax, but as Professor Lokken used to say, and probably still says even though he is in Miami, deferment, if done long enough is like a credit. 

So, the doom sayers and charlatans that say your rental property is going to leave you with enormous debts to the IRS probably haven't read through the entire section on excluding COD income.  Remember, to read to the end of the page, otherwise you might get soaked.  Insolvency and Bankruptcy are not the only ways of avoiding this kind of taxable income and even a well healed investor with a bad property can side step paying taxes on COD income if they find the right adviser to keep them dry.

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Wednesday, March 9, 2011

AG Foreclosure Settlement: Regulation Run Amok

Politicians are not going to fix the problems that we are in, not at least when there is money to be made in squabbling.  The Obama administration is backing the AG settlement offer.   Mr. Obama's lap dog, Timmy "the Taxcheat" Geithner (People wander why I didn't work for the IRS), put in his two cents saying this settlement was a necessary step forward, and  Elizabeth Warren, the architect of the Bureau of Consumer Finanical Protection, which was part of the Dodd-Frank Act of 2010 said "I still worry, a lot," about changes in the mortgage finance market.

The Republican response, led by Alabama's Senator Rich Shelby immediately attacked the proposal as an enormous overreach by a yet to be defined Bureau of Consumer Financial Protection (CFPB).  Mr. Shelby as well as a whole host of Republican congressmen despise the Dodd-Frank Act for its amorphous creation of additional regulatory agencies designed to create additional regulation of the financial sector.   House Republicans sent a letter to Mr. Geithner requesting proof of the legal authority granted to federal and state regulators to do what was proposed.   I truly don't have an opinion as to whether additional regulation is necessary or not, I do have an opinion on the creation of redundant regulatory arms.  Supposedly, the new CFPB will encompass and phase out the redundant aspects but my experience tells me that government isn't good at shrinking, like my waist line.

Now that we know that both sides are essentially fighting over the bone that is the CFPB, we can now look at the settlement in a new light.  The CFPB, as Ms. Warren has said, will "Demonstrate how we're going to deal with financial institutions who take on too much risk." Essentially, she is looking at the issue of the consolidation of the banking industry into giants like Chase, BofA, and Wells that forging themselves into the "too big to fail" model that precipitated the mess that we all find our selves in today.  Thus, the Democrats, through the creation of this new Regulatory Arm want credit for saving the American people from "too big to fail," and the Republicans, obviously not having the regulatory high ground, want a Legislative response that makes them out to be the White Knights of America's underwater homeowner.

A wise professor once pulled me aside when I was studying business at Valparaiso, and said, "Nic, when you are in government, where you are negotiating deals, make sure you trade apples for apples, and not for oranges."  What he was getting at, not that I have political aspirations, is that politicians tend to trade one thing for another when the fact is that they don't understand the value the items being traded. As long as the perception is that they got a good deal, it doesn't matter.  The problem is that sometimes it takes years to find out if the politician got a good deal.  Thus, if you are dealing in apples, you had better get the equivalent of an apple in return, otherwise you have done your constituents great harm.

The tools that are being put into the settlement agreement are fine.  As I said yesterday, they aren't really anything new, just consolidated to one place.  The $5 to $30 Billion settlement of cash in my opinion is a drop in the bucket when we are considering 1.2 million homes are being repossessed this year with an additional 5 million that are at least 60 days behind on their payments.  So, what is it that is being accomplished, other than a sound bite and picture in the paper?

Tuesday, March 8, 2011

AG Foreclosure Settlement: Parts to like, but at what cost?

Yesterday I posted on the AG Foreclosure Settlement, today I was finally able to read the 27 page draft that was allegedly sent to the biggest banks in America.  There are certain aspects of the proposal that have merit.  It contains tools such as closing the option of Dual Track Foreclosure which we discussed last week.  There are also requirements of providing documentation in Nonjudicial foreclosure states like Washington which are not otherwise required.  The proposal also includes the forced use of NPV analysis on determining the value of modifications and short sales as opposed to foreclosure, principal loan modifications, single point of contact with the servicers, and increased use of short sales.

These tools are really not all that different than many of the tools that we already have at our finger tips as attorneys.  Certainly, the tools are more spread out.  We have to weave together items of Consumer Protection, Real Estate, Tort law, agency, bankruptcy, and contract law to come up with some of our answers, but that doesn't mean the answers are not already available.  The AGs are packaging it into a nice little kit if you will. 

The problem that I have with the kit is going to be the expense.  If you look on page 26 of 27, you will find item VI Monetary Relief and there is a little phrase there that reads, "settle claims owed the government and/or to fund programs..."  This is where I find this proposal suspect as reported yesterday.  What is it going to cost to get the protections listed in the other twenty five pages, plus the money?  I believe that the banks are going to be asking for immunity from suit on the bad acts from private parties.  I believe that the tools already in place will be made ineffective by the AG's settlement and the only way to be allowed to use them is to fight with the AG who is supposed to be helping consumers beat harmful business practices.  Who is going to protect us from a duped AG?

It is too early to tell what the actual ramifications of this proposal will be, but considering that most AGs are political in nature, ie Rob McKenna from Washington using the AG office as a stepping stone to run for Governor, it is not surprising to find short sighted fixes.  Especially when we are dealing with all 50 states AGs and the banking industry and a handful of federal bureaucracies.  Stay informed, put in your two cents, because if we stand idly by, our government may give away our rights in the name of protecting the society.

Monday, March 7, 2011

AG Foreclosure Settlement and the Little Red Hen

I am fond of the children's story, The Little Red Hen.  To me, it has always stood for self reliance and capitalism.  When individuals share in the work, they share in the rewards, but when an individual cannot be bothered to lift a hand in the cause of industry, they are left to what they put their hands.  The Little Red Hen offered to include everyone, everyone declined, until she had produced her bread and then everyone wanted a slice.

Last Thursday, the individual states Attorneys General gathered in Washington, DC to discuss a settlement with the biggest banks over the improprieties in handling foreclosures throughout the United States.  The number that was reached, at least as reported in some places is $20 billion.

To you and me, that sounds really big.  $20 Billion with "b."  But, as you start to delve into the number, I have a flash back to Austin Powers and Dr. Evil putting his pinky to his teeth when he says a "million dollars" as if that were some astronomical amount of cash which would shock the civilized world.  Instead, we pat our mouths as the yawn emerges.

Imagine that in the US, where we have a population of nearly 300 million people and of that vast number of individuals, there were 1 million households that were affected by the housing crash.  No imagine, that these people that have lost anywhere from 15 to 50% of their house value in the course of 3 to 4 years, would offering them $20 billion even seem like it would act like a bandaid for the financial scar on their lives?  The amount being sought, is $20,000 per household.  That doesn't even cover the down payment most of these people put on their now underwater homes.

These families have searched the internet, sought out housing counselors, short sale specialists, and the smart ones have found attorneys that understand the significance of the battle that is being fought and have put up a good fight.  These little red hens, if you will, have gathered the wheat, ground it, made their dough, and baked it.  As they sit down to eat, it would appear that every farm animal that was too busy to be bothered has enlisted the AG's to broker a deal to get them a slice.

To be clear, I am not for the settlement, I think the consumer is being sold down the river.  The banks are going to walk with a slap on the wrist while the little red hens are told they can't eat their bread because the AG's made a bad deal, with bad people, all in the name of taking care of everyone.  The fact is, if you want protection (bread) get your own.  I work with a handful of good attorneys in the Puget Sound that have secured settlements and negotiated deals that make $20k look like pennies on the dollar.  The AGs can keep their settlement if it means that I can't do for my clients what I have been doing.

Thursday, March 3, 2011

Dual Track Foreclosures and Forbearance Agreements

Tools are good, tools help us save time, save money, and sometimes even save lives.  The term, forbearance is defined as refraining from something.  In the context of underwater homes and homeowners attempting to salvage their upside down property, forbearance sounds like a god send, the relief from the storm, a life-saver, a good tool.  When forbearance is coupled with "dual track foreclosure," forbearance shouldn't sound anything like a life-saver but more like a mill stone hanged about the neck of the homeowner.

Legislators in California are trying to implement a law that would make the activities of some home loan servicing firms illegal, the act of offering a forbearance agreement while simultaneously moving down the foreclosure path.  That would be the definition of a dual track foreclosure.  Senator Mark Leno (D-San Francisco) (no relation to Jay Leno) said "Banks should not foreclose on a  family's home until they inform the owner whether the loan can be modified to an affordable level...homeowners who qualify for modifications should get them - not a foreclosure notice."

The turn of phrase used in the news article, "modified to an affordable level," caught my eye and reminded me of a class action lawsuit I had read about.  The sign up for the case is found here, and is being brought against Aurora Loan Services LLC of Littleton, CO by Hagens Berman, a national law firm with offices here in Seattle.  The interesting thing about this case is that it is taking a judicial tack at what the legislatures are trying to make illegal.

THe complaint is being handled in U.S. District Court in California and can be read here, but the gist is as follows:  The homeowner goes into default by missing payments and seeks modification help to save the home from foreclosure.  Aurora Loan Services LLC continues the foreclosure process but finally comes to the homeowner and offers them a "forbearance agreement."  The agreement requires the homeowner to make a sizable up front payment followed by 4 to 6 monthly installments.  The amounts paid will not bring the mortgage current, so the homeowner continues to be in default.  The servicer is "checking to see if the homeowner qualifies for modification," and then when the homeowner magically doesn't qualify at the end of month six, the home is foreclosed, no additional notices are provided.

This is plausible scenario even here in Washington under the Deed of Trust Act.  The act requires direct notices to the homeowner in the form of the Notice of Default and the Notice of Trustee's sale which come a minimum of 120 and 90 days before the sale, but the sale can be unilaterally pushed back by the Trustee for up to 120 days.  Thus a forbearance agreement could be signed after an original date of sale is issued, the agreement would not interfere with the propriety of a sale as long as it occurred within 7 months of issuing the original Notice of Trustee's sale.  Do you see where this going?

The trustee issues the Notice of Trustee's Sale and almost simultaneously the Servicer issues a forbearance agreement which uses the possibility of a loan modification as inducement for signing.  The agreement asks for roughly two months worth of payments up front and then four additional installments to paid on a recurring day each month, like the 20th.  The agreement states that if the homeowner will provide required documentation, the Servicer will determine if the homeowner qualifies for a modification.  This is music to the desperate homeowner's ears, but its a sham.

The success rate of modifications under HAMP or otherwise is between 3.5% and 12%, depending on which governmental metric you want to follow.  The modification program is routinely used by the banks to keep loans that would otherwise seek refinance at another institution.  Thus the number of modifications for those that are desperate is probably even lower. Consequently, most of the forbearance agreements are not really promising to do anything for the homeowner.

The real problem with these forbearance agreements is the payment.  Under the Deed of Trust act, the homeowner can walk away from the underwater home and make no payments during the time of the foreclosure process.  So, each payment received under the forbearance agreement is essentially free money to the servicer who would not normally see any money during the process.

To add insult to injury, the Servicer receives higher fees when the loan is in default than it does when the payments are current.  The investors in the Mortgage Back Securities are thus not seeing a very high percentage of the money flowing from the homeowner, rather it is being siphoned off at the servicer and Trustee level.  I am sure you wouldn't be surprised to learn that the servicers and trustees are generally subsidiaries of large mortgage banks.

Bottom line, the forbearance agreement is most likely a tool to take money out of your pocket and not a tool to save your home.  Don't be a tool, tell the bank to shove the forbearance agreement and short circuit the dual track foreclosure before it gets started.

Wednesday, March 2, 2011

Zombie walk down Foreclosure Lane

To continue my B-Movie monster work, I though we would start in with Zombies, the walking dead. Doomed to roam the earth with no place to stop and call their own wit a deep seeded hunger for...jobs? Wait, we're not talking about zombies, we're talking about the 18+% of people not employed or under-employed. Does that sound high to you? If it does, clean out the wax because this is a brave new world where that shouldn't surprise you. What should surprise you is the media touting a dip to 9.1% unemployment.

In today's Seattle Times, the news actually caught the "catch" in the good numbers released today.  Supposedly, on a seasonally adjusted basis, joblesness in our corner of the country dropped from 9.3% in January to 9.1%.  The state economy added 11,000 jobs in January and everyone should be ecstatic...right?  Well, except if you don't seasonally adjust the numbers we actually had 47,100 jobs disappear.  Poof.

The next number to look at are underemployed and those that have quit looking for work, talk about walking dead.  That number is 18.4%.  That is nearly 2 percentage points higher than the national average of 16.7%.  Since 2009, the state has added only 20,200 jobs and we have an estimated 338,905 (pretty specific number for a government number) that are jobless.  If that is what we have to look at as success, it would take over 15 years to eat up our jobless rate.

In January I lambasted jobs and I believe that is very relevant now.  We still haven't seen the full force of layoffs at the state and local levels. Boeing will add new jobs with the Tanker contract, why that took so damn long I will never understand or at least never accept as being valid.  But those additions are not likely enough to offset the public sector contractions.

The problem that we are seeing here in WA is a stress on the hourly wage and the income of the average family.  That downward stress continues to pull on the housing market.  If you have $15 to $20 an hour workers, it will always be hard to afford $300,000 plus homes.  The loans will always be subprime and we will have a continued depression in housing prices.

Last week, the Oracle of Omaha, Warren Buffet, was quoted as forecasting housing recovery within a year.  I had great respect for that man up until about three years ago, but he has lost his Midas touch and I think that forecast is a self-serving statement.  One of those, I think therefore I am issues.  The indicator are not there for housing recovery as long as it is linked with jobs.  The walking dead will continue to shuffle down foreclosure lane.  Sorry for the downer, but truth isn't always pretty.

So, for an upbeat ending, what can be done?  Well, those that can find work, maybe not in this state, shouldn't be held back by a bad bank loan.  Your economic opportunity shouldn't be put on hold due to a underwater home consisting of WA property.  We have laws in this state that can allow for a worker to walk away from the home with money in his pocket and still get a good night sleep as he prepares for that new job. 

I had a client last month who had tried to work with her bank as her husband left town to find employment.  She came to my office in a fit, the bank, under a deed-in-lieu was going to hold her liable for the whole deficiency.  Not after we got done with them. The bank will be singing nonjudicial foreclosure under the deed of trust and the deficiency goes poof. She now has a clear plan, she will join her husband in his new place, her son will finish school here, and she will sleep like a log for the next couple of months.

The difference for her is a plan... some knowledge... and a pep talk.  We are not walking dead, just asleep because we are afraid to get out of the dreams.  The reality isn't so bad, for those that will go at with their eyes wide open, looking for opportunity, and taking it where they can find it.