Florida Asset Protection Blog

Forclosure Tax Effect: Imputed Income From Debt Forgiveness May Be Offset By Investment Losses

Many people facing foreclosure are concerned about income tax liability from the lender’s forgiveness of mortgage debt. If the mortgage lender does not pursue a deficiency judgment and writes-off the loan after foreclosure the lender could send the owner a IRS Form 1099 for imputed income for the amount of debt forgiven. In the case of a first mortgage, the debt forgiveness would be the difference between property value and mortgage loan balance; a second mortgage write-off creates an imputed income issue for the entire amount of the loan. There is no imputed income from debt forgiveness on your primary residence. Most imputed income issues are related to foreclosure or short-sales of investment property or second homes.

In response to a question from a Miami attorney I spoke with a local CPA concerning income tax treatment of debt forgiveness of investment real estate. The CPA is Lonnie Young usataxhelp.com. Mr. Young explained that imputed income after foreclosure and debt forgiveness often is offset by tax losses on the real estate investment. . Consider the example of a person who buys a house for $200,000 with a $180,000 mortgage. The house is lost to foreclosure when the value is $100,000. The lender sends the owner a 1099 for imputed income of $80,000 (mortgage balance less fair value). The foreclosure is a forced "sale" after which the owner has realized a tax loss of $100,000 ($200,000 purchase price less $100,000 value at foreclosure sale). The loss offsets imputed income so the taxpayer pays no additional tax.

The ultimate tax effect of imputed income depends on the owner’s use and tax treatment of the subject real estate. The CPA said that in the case of investment property, including vacant land or houses, the loss is a capital loss which is limited to $3,000 per year . If the house qualifies as Section 1231 business property (including rental property) the tax loss is characterized as a business operating loss which the taxpayer can write off fully in the year of sale. Based on what Mr. Young said, if your home facing foreclosure is rented for income then your tax loss would offset any imputed income from debt forgiveness. People facing foreclosure or short-sale of houses other than their primary residence may benefit if they have rented the home a current market rent even if the rent does not cover the mortgage payment.

The IRS may challenge the characterization of a 1231 business property where the property has been rented for less than 1 year prior to the foreclosure sale. Mr. Young said the IRS almost never challenges the one year write off where the home has been rented for more than two years.

You must discuss your individual situation with your own CPA or tax attorney. My discussion of this topic is based on a non-written opinion of one accountant. I am not a tax attorney and have not independently researched this important tax issue.

Inherited IRAs Not Exempt- According To Florida Court Decision

IRA funds are exempt from creditors in and out of bankruptcy pursuant to the exemption in Florida Statute 222.21(a)- except if your "IRA" is inherited, according to a recent decision by a Florida appellate court. The case considered a judgment creditor’s claim against the debtor who had inherited  IRA funds from his deceased parent. The parent started the IRA and contributed pre-tax money during his lifetime. The court recognized that the parent’s IRA was exempt from the parent’s own creditors during the parent’s lifetime. When the parent died, the debtor/son had the option under the tax law to withdraw all of his parent’s IRA money over a five-yearperiod or  retain the money in what the IRS rules call an "inherited IRA." An inherited IRA is not subject to a five-year distribution rule, and it requires the debtor/son to take minimum distributions annually- the distributions could not be deferred.

The court found that the language of 222.21(a) does not apply to inherited IRAs because the statutory language refers to the "original fund or account" of the IRA. The court also noted that the tax consequences of inherited IRAs are significantly different because although there is no taxation until withdrawal the beneficiaries of inherited IRAs are required to take annual distributions. The court found that the public policy behind IRA exemption to allow debtors to preserve assets for their own retirement does not apply to the named beneficiaries after death. A surviving spouse’s rollover IRA is not affected by this court ruling and remains exempt under the Statute.

I assume the debtor’s counsel s for the benefit of debtors.. This court elected to strictly construe the statutory language to find that inherited IRAs are outside the intended statutory exemption. On the other hand, I recognize a strong policy argument supporting this court’s decision. The exemption laws protect debtors during their lifetimes and generally do not extend to their heirs. Inherited money or assets in most cases is not protected from the heirs’ creditors. For instance, when a parent dies leaving his exempt homestead to his children the property, or the sales proceeds, is not exempt from the children’s creditors unless the children occupy the house as their own homestead. I assume the court reasoned that the parent’s IRA funds should not be exempt from the beneficiary’s creditors just because the money is held in a fund called an "inherited IRA" which is different in character and purpose than the traditional, tax deferred IRA account described by the applicable statute.

No Florida bankruptcy court has dealt with the same issue.

I suspect most Florida residents assume that all IRAs- all funds that qualify as IRAs under IRS rules- are exempt. This is no longer the case. If you have an inherited IRA and are concerned about asset protection you should consider other asset protection tools to protect this money. Parents concerned about protecting their estate from their children’s creditors should get professional financial or legal advice to structure their IRAs so they will be protected after their deaths.

The case is 2D08-6428. Thanks to Jesse Toca for bringing this case to my attention.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida.

Homestead Questions: Size Within City And Ownership Period For Bankruptcy

A client asked me two homestead questions which questions I have previously heard from other clients or email inquiries. This client owned a homestead with significant equity within a municipality. Homestead properties within a city up to ½ acre in lot size are protected under the Florida Constitution. The client said he intended to buy a ½ acre lot adjoining this existing homestead as an investment, and he wanted to know if the lot would be protected from creditors. My opinion is that the lot purchase would jeopardize the homestead protection of his existing house. Homestead includes the property upon which your residence is located as well as all contiguous land. If the client purchased the adjoining lot and took title in his own name the adjoining lot would be incorporated into his homestead and the size of his entire homestead would increase from ½ acre to a full acre. Thereafter, only 50% of the total homestead would be protected within the city limits. The client could not apportion protection to the original lot on which the house is situated. The purchase of the contiguous lot in his own name would forfeit protection of 50% of his house value. A better strategy would be to form a limited liability company and have the LLC purchase the adjoining lot. Because the client does not personally own the new lot it would not add to the size of his homestead. Land owned by entities, as opposed to natural persons, cannot be homestead property. The LLC would give some, although imperfect, asset protection.

 

The second question concerned the bankruptcy rule that requires a bankruptcy debtor to own a homestead property for 40 months in order to get unlimited homestead protection in bankruptcy court. If a debtor owns homestead 1, sells homestead 1 for a profit, invests the profit in homestead 2, and then files bankruptcy, the time of homestead includes ownership of homestead 1. A client posed the following question: the client owned homestead A for many years. During the real estate crash he did a short-sale of homestead A and immediately purchased homestead B with new money. The client believes that since he can continuously owned a Florida homestead, including A and B, for more than 40 months he should have unlimited homestead exemption in homestead B. I don’t think the law is intended to add the ownership period of homesteads A and B in this example because no equity from A was invested in B. Ownership periods are grandfathered when the debtor transferred equity (sales proceeds) from one homestead to a new homestead. Investment of money other than homestead sales proceeds begins anew the ownership clock for purposes of the Florida homestead exemption- that’s my interpretation.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida    

Cash Payments Offered To Tenants Of Foreclosed Properties

As previously mentioned on this Blog a new federal law protects tenants of foreclosed properties. The law requires the lender to honor the terms of bona fide leases after the lender takes back the property at foreclosure sale. At least one federal lender, "Freddie Mac" is offering to pay tenants to move out of properties after foreclosure. I received a letter from a law firm representing Freddie Mac addressed to the "unknown tenants" who leased and occupied a foreclosed house wherein Freddie Mac offered the tenants $4,000 cash to leave the property in 30 days. The proposed settlement required the tenants to deliver the property in broom clean condition. Freddie Mac offered to deliver a check payable to the occupants who sign the stipulation. Not only does the new tenant law protect tenants’ lease occupancy rights after foreclosure, but the federal government mortgage agencies are now paying tenants to move into another dwelling.

Making cash offers to unknown tenants is generous and also advantageous to the mortgage lender which wants quick control of the foreclosed property. The practice also invites abuse. A homeowner facing probable foreclosure could enter into bogus lease contracts with existing tenants, or even fake tenants, and then try to extract payments from lenders. Fake lease arrangements are certainly civil fraud and may also be criminal. Many borrowers lied on mortgage loan applications, and I suspect some will use misrepresentations to gain cash payments offered by lenders after foreclosure.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida

Mortgage Foreclosure Defenses Using New Tenant Protection Laws

Tenants of single family homes had been facing sudden eviction when the homes they rented were sold to a mortgage lender at a foreclosure sale.  After the foreclosure sale the mortgage lender evicted the tenants even though the tenants’ lease payments were current. To better protect tenants victimized by foreclosures against their landlords Congress passed a law which required the non-occupant purchasers at foreclosure sales (such as banks) to honor existing leases on the foreclosed property provided that the lease was bona fide and the tenants were not in default. Some "foreclosure defense" companies are using this new law to delay foreclosure law suits. These homeowners are creating bogus lease arrangements to prevent the lenders takeover of property and gain negotiating leverage for the homeowner.

Here’s how a typical defense scheme could work- I am omitting some details and issues for sake of the example. Assume Joe Homeowner has ceased making mortgage payments and the bank is threatening foreclosure. Joe creates a revocable trust which he calls "the Save My Home Trust" ; Joe is the sole beneficiary of the trust, and Joe names a friend or business associate as trustee. Joe sells his home to the trust for nominal consideration over the mortgage balance. The trust leases the property to Joe for a below-market rent for a five year term- a sale and leaseback arrangement. When the bank sues for foreclosure the trust asserts typical foreclosure defenses, and Joe intervenes as the tenant arguing that the bank must honor his five year lease. Obviously, a court will eventually rule that the lease is not bona fide and is not a valid defense. However, the additional defense frustrates the bank’s foreclosure suit and gives Joe more power to either live in his house for free or negotiate a favorable settlement.

I have never defended a homeowner in a foreclosure suit.  However, based on conversations with asset protection clients I have learned  that mortgage defense attorneys and non-lawyer companies are using varieties of this lease defense which was designed to protect bona fide tenants in foreclosed properties .

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida 

Does Joint Bank Account In Non-Entireties State Automatically Become Tenants By Entireties Property When Family Moves To Florida?

Suppose a husband and wife own personal property, a bank account for example, jointly with rights of survivorship in a state that does not recognize tenants by entireties ownership of personal property, and they intend to move to Florida. Florida recognizes tenants by entireties of personal property, and under Florida law all personal property owned by married couples with rights of survivorship is presumed to be entireties property. The question for this fact situation is whether the couples bank account in another state’s bank becomes protected entireties property when the couple moves to Florida as permanent residents.

 

Based on my initial research for a client this week I think the answer is "no." A bankruptcy court held that a promissory note owned by a married couple in a non-entireties state did not morph to protected entireties property just because the family moved to a state (Florida) which recognizes entireties. The court said that the nature of the debtor’s interest in property should not change just because the debtor moves across state lines.

If you have a joint bank account outside of Florida and are considering moving to Florida in part for asset protection purposes I suggest you and your spouse open a new, tenants by entireties bank account after you arrive in Florida. In most cases you can defend any fraudulent conversion arguments if the account where you came from was owned jointly and most of your other property was also jointly held.

published by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida

Criminal Prosecution For Mortgage Fraud During Real Estate Bubble

Many of my clients are facing the prospect of lawsuits for personal liability on account of default on mortgages. Some of these clients have invested in many investment properties which are now upside down and unsustainable. During the real estate bubble many people inflated their income and assets on mortgage applications. My clients often ask me if the mortgage company will refer their case to the government for criminal prosecution because the clients had lied to their mortgage company in order to get financing. This week I received a call from a criminal defense attorney who was referring a client to me for asset protection advice. During our conversation I asked him if the mortgage companies or the government were prosecuting mortgage fraud related to the real estate bubble.

The criminal attorney said that state and federal governments are actively pursuing mortgage fraud cases against large builders and mortgage companies. He has seen no criminal prosecution related to owner occupied properties. The attorney said that so many people lied to get financing for their own homes that the government has not way to fairly decide who to investigate and does not have resources to handle so many cases. The FBI is prosecuting some investors who fraudulent obtained mortgages on numerous investment properties where the mortgage fraud is egregious. The attorney has been told by prosecutors that the FBI will not even consider prosecuting mortgages less than $500,000 and will rarely investigate mortgages under $1

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida