Congressional Stocking Stuffers, Bank Street Scroug, and Mortgage Debt Forgiveness Relief - Bless You

Mr. Ryan has been playing Santa Claus this week in doling out spending provisions and tax incentives.  I didn't know that Santa had such an in with the Federal Reserve and the ability to just continue to print money, but at least a few of these incentives will be a cause of great joy and I expect at least one Hallelujah Chorus will resound from my clients. 

In 2007, which seems like a lifetime ago, maybe even in a galaxy far away from here, Congress enacted a provision under section 108 of the Internal Revenue Code that gives relief to those that received relief from their housing lenders.  Sometimes that relief came in the form of a principal reduction, that happened like three times ever.  The most common way was the house was sold at foreclosure auction or at a short sale and the lender didn't sue the living bejesus out of the now homeless borrower.  Thanks for doing a guy a solid, JP, Wells, BOA, and the rest of you guys!  You are all swell.

As the adage goes, insult to injury, the swell fellas at the bank send out a greeting card of sorts. Its not a Christmas card, but more of a, "hey we foreclosed, and then we ratted you out to the IRS" type card. The 1099-C that comes in the mail in January, maybe February of the following year tells you that you received a cash benefit for them foreclosing your house and not suing you.  Oh, and they send an identical card to the IRS, with all your information on it.  So, the IRS then checks its naughty list and sees if you claim that amount on your 1044 tax return.  If you don't, you get a nice letter saying you owe thousands of dollars in taxes.  Merry Christmas to you in July!

So, back to Mr. Ryan and his stocking stuffer.  The proposed packages that rank in the trillions of dollars, which no average human has any capacity to comprehend (seriously, its like touching the mind of God) includes an extender for the 2007 act.  This means that you can take your 1044 and attach a form 982 and explain that the Bank Scrouged you and that you don't actually have any money from that transaction wherewith to pay any taxes.  The IRS will accept this and you will have Happy Homeless year for 2016. 

So, with these glad tidings I bring, I wish you a Merry Christmas and a Happy New Year.  If you have questions about the content of this blasphemous post, please direct them to me at my office or by email.  God Bless us Everyone!

Realtors Treading Sharky Tax Waters

I received a call this morning from a client that was in a huff about some information that his real estate broker had given him about cancellation of debt income.  Discharge of indebtedness income, or cancellation of debt income, or COD income can be present in a short sale.  I am heartened that the Realtor was aware of the issue, but I think he started swimming into some deep waters when he started advising his client on the ramifications of the transaction.  Those waters don't have a readily identifiable bottom and that butt clenching feeling you have is directly correlated to the sharkiness of that water.

 If we get into the way back machine and head into 1931, the US Supreme Court decided the Kirby Lumber case giving rise to this kind of income.  It has since been codified, but with the codification, there were a number of exclusions that came along with it.  Not all debt is created equal in the sight of the law, and particularly the debt that is canceled because someone has met hard luck.  Up until the beginning of this year, the Mortgage Debt Forgiveness Relief Act of 2007 that had been extended through 2013 provided most owner occupied real estate a break if the property went back to the bank.  So, when dealing with short sales and foreclosures through last year, there was an exclusion available up to $2M on COD income derived from the loss of your personal residence. 

That provision was supposed to be extended, and had been expected to be extended by Congress, but because of the political infighting of our broken two party system, sensible provisions like this were held hostage by both sides and never extended.  Its not too late, but we are starting to fear this one is dead in the water going into midterm elections.  Consequently, short sales and foreclosures this year do not have a readily available exclusion.  This is where Realtors have lost that nice sandy bottom that they were standing on the water gets dark and deep fast.

The Internal Revenue Code has more loop holes than a fisherman's knot and this is where my Realtor friends are just treading deeper water.  My suggestion is that if you don't like swimming with the legal sharks in deep water, then simply point your client in the direction of competent counsel.  The Realtor that advised my client simply didn't know that when I had suggested short sale to my client it was with full knowledge that another exclusion was readily available.

This particular client had gone through a bankruptcy.  Again, the hard luck aspects of the exclusions softens the landing for the client that is losing his property.  There are also exclusions for those that have extensive debt and would qualify for relief because of insolvency. My favorite for investors in residential real estate has to do with such properties held outside of a C-Corporation because the insolvency is essentially limited to the single property and not the taxpayer's complete portfolio.

So, before you get your client all worked up over tax issues on his short sale or foreclosure, have him speak with the sharks in deep water, preferably by phone, sometimes its hard to tell food and friends apart.

The Tax Cookie Jar

Did you ever grow up with a cookie jar?  My mom had a cookie jar, and that jar had a lid, and it was noisy when you took it off.  In retrospect, I believe that was on purpose, because lets face it, my mom liked cookies as much as I like cookies and she wanted to make sure there were enough cookies for everyone.  She could hear every time that tin lid came off and I can still hear in my mind, my mother's voice yelling, "Put it back!"  As a dutiful son, I would put the cookie back and then skulk off knowing that I had been thwarted in my effort to get more cookies than someone else.

As the owner of your business, you need to view some of your bank accounts like that cookie jar.  When you have made enough money that there is plenty of money to go around, it doesn't seem like a big deal that a few extra cookies make it off to God knows where.  However, problems come when cash flows get tight and there are simply not enough cookies to go around.

There is a temptation in business to look at those cash flush accounts that were earmarked for sales tax, employment taxes, and even B&O taxes that you think that if you sneak a little now, you will be able to put it back later.  Worse, is when your business manager thinks the same thing.  This is where Mom has to yell into the kitchen and say, in no uncertain terms, "Put it back!"

Despite the rhetoric in the national news about improving economies, higher employment, and a general anathema of saying anything negative about business prospects, I am here to tell you that main street businesses and their owners are not seeing overwhelming recovery.  I would say, that in the last five years of advising businesses, we still haven't seen pre-recession revenues, much less profits.  Business is still scrapping and fighting for every dollar and sometimes there just does not seem to be enough dollars to go around.

So who gets the cookie?  We tend to think that because of the self reporting aspect of the tax system and that it will be at least another year before you have to come clean to the Department of Revenue, or the Internal Revenue Services.  You think that you should take from those accounts to cover your short term cash gap.  The reason why I tell my business owners to not do that, is for the simply reason that you have no proof that you will make that money back.  I am not a pessimist, but the reality is that if you cannot pay for it now, taking essentially a credit loan  from the DOR and IRS is not your best business practice.  There are better creditors to use, and ones that will not attach the moniker of tax avoidance to your transaction.

Here is an analysis of the why and how.  Suppose that your business goes belly up six months from the time you take the cash from these tax accounts.  (Again, I am not a pessimist, but we are planning for worst case scenarios.)  Under Washington law, you can wind up the business, shutter the doors, and walk away from the business held debts.  Except that you cannot in regard to the debts to the DOR and IRS.

In Washington, you must receive a clearance from DOR to close the business.  Until DOR has been paid, you are on the hook and subject to the harassment of the creditors.  Additionally, DOR has a right to the sales tax proceeds your took.  Remember, Sales Tax is not your tax, but the tax from your customer.  You hold it in trust on behalf of the State.  If you fail to pay that amount, Washington law allows the DOR to reach past your now defunct business venture and into your pockets as a responsible individual for the business.

Likewise, the 940 and 941 employment taxes that you are to remit are the taxes of your employee, not your taxes.   You again stand as a fiduciary for that payment.  Failure to pay timely can create a situation where the IRS can reach past your business and into your pockets.  Federal Tax Lien anyone?

The next part of the analysis is in looking at personal liability.  Say you were required to personally guarantee the lease, your equipment purchase, your supplier's account, and the company credit card.  Each of those entities, once the business has been wound down, have unsecured claims against you.  Each of those are dischargeable in a bankruptcy.  Guess which two accounts are not dischargeable?  That's right genius, the DOR and the IRS accounts will haunt you even through a bankruptcy.

Now, that we have travelled the dark road and know what the pessimistic view looks like, we can plan in the present; the noisy lidded cookie jar.  It is the recommendation that a separate account be established to hold sales tax and employee taxes.  These should have greater protections on them, such as dual signature checks, or at least unlinking them from the general business account so that transfers cannot be easily made from those accounts to your primary business accounts.  You may also want to create alerts on your smart phone for when transfers come from the accounts.

This protects the accounts certainly from the inadvertent use of the funds, but more importantly forces the owner and the managers to make a conscious decision to pilfer the account.  Remember, that money is not your money, Fiduciary.  The extra work will ensure that extra thought will be put forth and hopefully thought will provoke good behavior toward your business.  Every time that you open that transfer window on your bank's website, I want you to hear my mother's voice yelling at you across time and space, "Put it back!"

Why $26 Million Won't Keep you From Bankruptcy

Anyone that knows me, knows that I have a voracious appetite for sports generally, and football Vince Young and the judicial order to sell his possessions.  Vince Young, as you may recall was passed over by the top team, dropped to the Tennessee Titans, but still slotted well enough that his rookie contract included a guaranteed provision of $26 million.  The average human will not see that kind of earning power in a life time, much less over the course of 5 years.
specifically.  I not only love the gameplay, but the business side of professional sports has always been a fascination.  This week, Tully Corcoran of Fox Sports posted an article in regard to

Yet, in regard to the article, Mr. Young became indebted and sought a short-term loan during the lock-out year a couple years back.  The loan was there to keep other loans afloat until he could again draw on income as a player.  This is where this story becomes relevant to my clients and shows that income and earning potential are only one part of healthy finances.  Mr. Young, in addition to a huge salary, had a huge amount of credit.  He bought homes, cars, vacations, jewelry, etc. and instead of budgeting this in regard to his income, he used credit to enjoy now that which would be paid for later.

The problem with credit, is not the credit itself, but the over use or over leveraging that takes place. Too many borrowers look at the fact that they have so much income, that they can take on the additional $100 payment here or the extra $50 payment here.  Surely, the one account isn't the problem until the final straw that breaks the proverbial camel's back.

Mr. Young had too much credit and when his playing days were finished, as the article states, he will be allowed, after paying back his creditors by auctioning his possessions, to keep about $60,000 or less than two tenths of one percent of what he was guaranteed in his first contract.

So, we must look at the debt to income ratio and determine if you are fiscally sound, or need to back up a little bit on your consumption.  Your home should not exceed 28% of your gross income, but underwriting will allow up to 31%.  If your fully amortized loan payment, meaning your principal, interest, taxes and insurance payment is greater than 31% of your gross income, you have too much house.

Secondly, you need to look at the total debt ratio.  36% is a reasonable amount that can edge toward 43%.  This does not mean that we are adding the principal home loan amounts to minimum card payments, but payments that would actually pay back the loans that you have.  If you are paying on minimums and are sitting at 36%, you may well be closer to 50%. 

If you find that your ratios are this high, you are an illness, car accident, or lay off away from having a court order you to liquidate.  It is time to seek some professional counseling on your debts and see what you can do to not end up like Vince Young.

Short Sales Outpacing Modifications

It may come as a surprise to some that banks would prefer that you short sell your property than modify it.  It may also surprise you when I slap that surprise off your face with a little education.  Think of a mortgage as a single share of stock.  At the time that the bank lent the money, it was like a purchase of a stock certificate.  It had a certain value on the market at the time, but the value changes with time.

Like any other stock, speculation has a role to play in "market" value.  In 2007, speculation by both corporate buyers, flippers, and a glut of lending lead to an inflated purchase points.  With the recession, housing, in part because of lousy lending underwriting, took huge losses, some sectors losing up to 70% of value in the matter of weeks.  Bank, though institutional and without flesh and blood personas, are run by humans and the banks did what a lot of investors do at a time of downturn, they sold.

The sale of these mortgages/stocks were done at a fraction of the value that had been paid at the time of lending.  You hear the expression "pennies on the dollar," well that would have been accurate here.  In addition to voluntary sell offs, some banks simply crumpled under the stress.  Lehman Brothers, Wachovia, Washington Mutual, Country Wide were some of the biggest names to blink in the face of the maelstrom that was coming and the assets that represented main street mortgages were purchased pennies on the dollar.

Fast forward about five years and you are contemplating your ability to pay for your home.  It no longer has the value it once did, your interest rate is locked in 2007 purgatory, and you are wondering why you owe more to your new bank than the house is worth.  If I described you with pinpoint accuracy, it is because I write fortune cookies on the side.  The next best option to you is to go to your bank and ask it to modify the loan to a more affordable version for the post-apocalyptic you.

The bank comes back and says no.  It has a myriad of reasons that it hides behind, such as poor DTI, you make too much, or my favorite, your loan doesn't meet investor guidelines.  Let's take a machete and cut through this crap.  What the bank is saying is that because it bought your house for pennies, it can make money simply selling it to whoever is willing to buy it.  If it modifies your loan, then it will have to wait up to 40 years to see a real return on its money.  So thanks for playing but if you don't want to pay, it doesn't care.

In reading through the article linked above, I will admit that my offices have had an above average result in obtaining modifications.  Short sale is usually a secondary option for my clients and the results play out in many modifications.  It has to do a lot with knowing the pressure points, knowing the options, and then being persistent like a Gonzaga Bulldog when it comes to pushing for that outcome.

If modification is something that you crave, there are options available in Washington.  The Foreclosure Fairness Act Mediations provide a terrific forum for us to get results for our clients so that the norm of short sales outpacing mods does not have to be your outcome.

Foreclosure Ninjas and Shadow Inventory

Under the stealth of cloaked balance sheets and un-realized transactions, our nation is being overrun by foreclosure ninja.  It was reported in DS News that between GSEs like Fannie and Freddie and separately by HUD, that 1.7 million properties are in the shadows.  This number is in addition to the nearly 200,000 properties that are held as REO properties ready for sale by the GSEs and HUD.
infiltrated by the shadow inventory of properties held by banks, GSE's and HUD that are more than 90 days in arrears but not yet in foreclosure. 

A corollary article stated that year over year, the Washington market has seen a jump in foreclosures by 67 percent in the Seattle-Tacoma-Bellevue metro area.  If we only worried about the metro, we would be neglecting the fact that foreclosures have reached far into suburbia and the rate for the entire state is 88% above last year's numbers.  Now you may wonder, how in the world could we as Washingtonians be facing such horrendous news when we have clearly seen a year over year increase in values?

The Wall Street Journal on Sunday ran an interesting article that hit on some of the reasons why we are seeing these dichotomous events here in Washington.  Corporate purchasers are entering the market in numbers that belie the significance of the collective impact on the housing market.  Simply put, as that last sentence was full of legal speak, the corporate buyers are only buying a few home, but those purchases are significantly swinging prices.

So what does that mean those that are sitting on a home right now?  It means that in the short term, your home value is going to increase.  It means that in the mid term you could see a dramatic change in value of upwards of 30%.  If you don't believe me, and there isn't really any reason that you should, so check out Mr. Harry Dent, I know I would change my name too.

The recovery that is a buzz in the markets is smoke, the un-foreclosed homes, the shadows, and the ninja silently stalking in and out is a second downturn.  Smart investors, homeowners, and businesses will trim debt while they can, cinch the belt and look for opportunities that will grown in down markets.  Even sneaky foreclosure ninjas can be beat with understanding where the smoke and shadows are and employing a comprehensive strategy for defeating them.

WSC Slaps Quality as Trustee

Thursday, a decision by the State Supreme Court held that Quality Loan Services failed to use its own best judgment in an impartial manner toward both the beneficiary (read Big Bank) and the borrower (read You).  Consequently, the Trustee breached its duty of good faith and violated Washington State consumer protection laws.  You can read that last sentence as "Trustee, you will pay the homeower's attorney's fees." If that is isn't a slap in the face, then I don't know what one is.

In litigation with numerous servicers and trustees over the last three years, I was told by the Trustee on more than one occasion, "we do what the bank tells us to do."  That, according to the State Supreme Court is a direct violation of the consumer protection act and actionable.  Trustees will significantly review the communications between its staff and the public (and public's attorneys) and make some changes.  I do not think there will be drastic changes, but the spector now looms.

One thing that I do worry about is that overzealous attorneys, quick to obtain attorney's fees, will force what we are seeing out of California, judicial foreclosure.  Be thoughtful in what you bring to court.