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Is Your Foreclosure Really Behind You?

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As Yogi Berra once said, “It ain’t over till it’s over.” Last year, the phenomena of “zombie deeds” came to light when it was discovered that homes vacated by their owners under the belief that they had been foreclosed really weren’t foreclosed at all and the owners still owned the house.

Now the specter of deficiency judgments from foreclosed properties is haunting former homeowners. Last month, Fannie Mae came under fire for pursuing money still owed on homes that were given up. The New York Times highlighted the practice of enforcing deficiency judgments obtained by the dreaded robo-signers in Florida.

What Is a Deficiency Judgment?

A deficiency is measured by the difference between what you owed on the mortgage (including all court costs and attorneys fees) and the amount recovered by the lender by foreclosing on the property. With property values lower in many areas than they were pre-recession, the value recovered by the lender is likely to be much less and a deficiency is a very real possibility. So you could give up your home and still owe the bank money on the loan you used to finance the house. Not every state allows deficiencies, and those that do allow it usually limit it in some way. As with any legal matter, it is best to check with an experienced attorney in your area.

Deficiencies can also occur in short sales. A short sale is the voluntary sale of your home for less than what is owed. The lender may release the mortgage, but not release the debt. The lender takes what they can get now, but may require you to pay more later. You should negotiate this issue.

The Ghost of a Deficiency Can Haunt in Many Ways

It’s bad enough that you lost your home to foreclosure, but the fallout can follow you in unexpected ways. The most common consequence of a deficiency is the dreaded 1099 IRS form that strikes at tax time. IRS rules allow the lender to declare that the money still owed on the deficiency is income to you, so you have to pay taxes on it. An exemption does exist in the tax law, but general relief expired at the end of 2013 when Congress failed to renew it. The House of Representatives recently passed an extension for this year in HR 5771, but the Senate still needs to add it before December 31st or an estimated 170,000 families will face a large tax bill in April.

A deficiency can also haunt for a very long time. For instance, in Connecticut where I practice, a deficiency judgment is valid for 20 years and can be renewed for another 20 years. Again, different states have different rules on enforcement. Imagine that your foreclosure is a distant memory and suddenly a debt buyer obtains a court order to attach your pay or execute against your assets as a result of an old deficiency judgment. This can occur without warning at a time when your finances have completely recovered and you have the most to lose.

Then there is always the issue of your credit report. Having a foreclosure on the credit report is bad enough, but showing that you still owe money on that loan only adds insult to injury. Under the Fair Credit Reporting Act, bad debt drops off your credit report at seven years. The same is true for deficiency judgments unless your state allows for a longer period of enforcement, such as Connecticut’s 20-year period. (See 15 U.S.C. §1681c.)

Solve the Tax Problem

If Congress does not act this year to extend the exemption from income, there are ways to avoid the debt of a deficiency judgment. The Tax Code has long held an exemption for those who are insolvent. IRS Form 982 contains the calculations necessary to show that you are insolvent. Insolvency means your debts exceed the value of all your assets. If that is true, then you will owe no tax.

Solve the Debt Problem

To avoid the debt, you have to discharge it. That means fighting the foreclosure to prevent the entry of a deficiency, if it is allowed in your state. Again, states have different rules. In Connecticut, a lender only has a narrow window of 30 days to file the Motion for Deficiency. California does not allow them at all. Your mileage may vary.

You can also file bankruptcy to discharge the deficiency debt. Coupled with loss of employment, deficiency judgments are the most common cause of bankruptcy filings. A bankruptcy filing also satisfies the calculations of Form 982, but you have to file bankruptcy in the same tax year as the issuance of the 1099. If you do not do so, the deficiency judgment may still be discharged, but the tax debt may remain.

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