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Home Foreclosures: 10.4.1 Deficiency Judgments Defined

In most states, if the foreclosure sale price is not enough to pay off the loan balance and any allowable foreclosure expenses, the lender may sue the borrower for the balance—the “deficiency.” A deficiency judgment can be satisfied by garnishing wages or attaching other non-exempt property. Though a lender may decide not to sue for a deficiency when it seems unlikely that the homeowner will have any assets to satisfy the judgment, foreclosed homeowners should at least be aware of the possibility of a deficiency action after a foreclosure.

Home Foreclosures: 10.4.2a Statute of Limitations for Deficiency Claims

Because a foreclosure sale is a precondition to a deficiency claim, the statute of limitations for a deficiency claim runs from the time of the foreclosure sale, or shortly thereafter, and not from an acceleration or the time of the default.299 A borrower cannot raise a statute of limitations defense until the plaintiff commences a legal proceeding for a deficiency judgment.300

Home Foreclosures: 10.4.4 Creditor Must Prove the Deficiency Amount

When a creditor seeks a deficiency, the creditor must prove its right to that amount.345 Scrutinizing all aspects of the sale and accounting is critical, particularly in a non-judicial foreclosure state. A valuation of the property, for example, can be contested on the grounds that it is not supported by sufficient evidence.346 In a judicial sale, the judgment order itself tells the official how to distribute proceeds from the sale.

Home Foreclosures: 10.4.5 Deficiency Claims Are Unsecured

If a family is obligated for a deficiency, keep in mind that this debt generally is not secured by any of the family’s remaining property until a judgment lien is obtained.351 The family at this point could file bankruptcy and discharge the deficiency as an unsecured debt. Moreover, even if the creditor obtains a court judgment for the deficiency, it still cannot seize exempt property to satisfy the deficiency.

Home Foreclosures: 10.5.1 Procedure

If the foreclosure sale yields more than the amount owed to the foreclosing mortgage holder, a surplus is available for distribution, first to pay off junior liens on the property, and the balance to the former owner. There is significant variation among state procedures as to how and when sale proceeds, including surpluses, are distributed.

Home Foreclosures: 10.5.3 Steps Homeowners Should Take

The former homeowner should evaluate other parties’ claims to the surplus. A successful challenge that reduces the amount to which a lienholder is entitled increases the share available to the homeowner, unless even the reduced amount going to junior lienholders uses up all the surplus. In particular, review lienholder claims for fees and costs associated with foreclosure,381 or a lienholder’s failure to properly rebate pre-computed interest or insurance premiums.

Home Foreclosures: 10.5.4 Relative Rights of Judicial Lien and Homestead Exemption

While most holders of a lien based on a security interest take priority over the homeowner as to recovery of the surplus, this is not the case with a judicial lienholder. The debtor’s homestead exemption, if provided under state law, should be paid ahead of any claims of judicial lienholders.384 Consider, for example, a $100,000 surplus, a $50,000 lien following a judgment on credit card debt, and a $90,000 homestead exemption.

Home Foreclosures: 10.5.5 “Surplus Retrieval” Consultants

During the current foreclosure epidemic, a cottage industry of “surplus retrieval” consultants has emerged. These scammers offer a “service” of assisting distressed homeowners through the maze of procedures surrounding a foreclosure sale. The consultants typically end up with a lion’s share of any surplus, or simply take money from financially strapped homeowners when there is no likelihood there will ever be a surplus.

Home Foreclosures: 10.7.2.1 When Is a Gain Taxable?

For tax purposes, a foreclosure sale, repossession, deed in lieu, or voluntary return of the property is treated the same as a voluntary sale.432 If the amount realized at the foreclosure sale is greater than the taxpayer’s basis in the property, there may be a taxable gain.433 The gain is recognized when the homeowner’s rights are cut off—usually at the foreclosure sale, but potentially at the expiration of the redemption period, if that is in a later tax year.

Home Foreclosures: 10.7.2.2 Calculating the Amount of the Gain

The gain is measured as the difference between the amount realized at the foreclosure sale and the homeowner’s adjusted basis. The homeowner’s adjusted basis includes the purchase price of the property, including any purchase money mortgages, plus the cost of any capital improvements made to the property by the homeowner.440 The basis does not include costs of routine repairs or maintenance, even if performing the repairs increases the value of the home.

Home Foreclosures: 10.7.2.3 Lenders Reporting of the Amount Realized

Lenders should send the taxpayer a Form 1099-A showing the foreclosure bid, the outstanding mortgage debt, and the lender’s fair market valuation of the property. If taxpayers disagree with the lender’s valuation of the property, they should request that the lender prepare an amended Form 1099-A. The taxpayers should also be prepared to submit evidence of the actual fair market value and should maintain this evidence in their tax files.

Home Foreclosures: 10.7.3.4 When COD Need Not Be Reported

Discharged debt less than $600 need not be reported.460 Discharged interest and fees also need not be reported,461 although they may be reported.462 There is no penalty imposed on creditors for failing to report discharged disputed debt,463 and creditors should not report debt that was never due and owing.464 Debt that is discharged by operation of law (

Home Foreclosures: 10.7.3.5.1 What is a Form 1099-C?

Under the Internal Revenue Code, lenders must file Form 1099-C to report most discharged debts.469 A Form 1099-A should not be used to report COD, but only the amount realized from a transfer of the property.470 Nonetheless, sometimes a Form 1099-A will be interpreted by the IRS as reflecting COD income.

Home Foreclosures: 10.7.3.5.3 Improper filing of a Form 1099-C; use of a Form 1099-C to defeat collection actions

Compliance with Form 1099-C reporting is not a safe harbor from state or federal debt collection practices claims.485 Intentionally false or misleading Form 1099-Cs, or the threat of filing a Form 1099-C, may be grounds for claims based on federal or state fair debt collection practices.486 Filing a false Form 1099-C is unlikely to give rise to claims under the Internal Revenue Code for filing a false information return with the IRS, because Form 1099-C’s are not listed among the covered returns

Home Foreclosures: 10.7.3.6 Taxpayer Reporting: Form 982

Individual taxpayers have an independent obligation to report discharge of indebtedness income to the IRS, whether or not the lender issues a Form 1099-C. Practitioners should advise taxpayers, if there is reportable discharge of indebtedness income, to file a 1040 and attach Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness). Form 982 allows taxpayers to claim applicable exclusions from COD income.492

Home Foreclosures: 10.7.4.2 Insolvency Exclusion

COD income is excludable from gross income if the taxpayer is insolvent prior to receiving the discharge, to the extent of the insolvency.498 Insolvency is defined as an excess of liabilities (including the debt being discharged) over the fair market value of assets, as determined immediately prior to the discharge.499 COD income greater than the insolvency is not excludable.