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What is a 1031 and their time lines?
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Freddie Mac and Fannie Mae Loan changes that effect investors.
Short Sales in Real Estate - How to Handle Real Estate Short Sales
How To Do Short Sales
There are many ways to lose a home but signing away ownership in a manner that destroys credit, embarrasses the family and strips an owner of dignity is one of the hardest. For owners who can no longer afford to keep mortgage payments current, there are alternatives to bankruptcy or foreclosure proceedings. One of those options is called a "short sale."
When lenders agree to do a short sale in real estate, it means the lender is accepting less than the total amount due. Not all lenders will accept short sales or discounted payoffs, especially if it would make more financial sense to foreclose; moreover, not all sellers nor all properties qualify for short sales.
If you are considering buying a short sale, there could be drawbacks. For your protection, I suggest that all borrowers:
As a real estate agent, I am not licensed as a lawyer nor a CPA and cannot advise on those consequences. Except for certain conditions pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, be aware the I.R.S. will consider debt forgiveness as income, and there is no guarantee that a lender who accepts a short sale will not legally pursue a borrower for the difference between the amount owed and the amount paid. In some states, this amount is known as a deficiency. A lawyer can determine whether your loan qualifies for a deficiency judgment or claim.
Although all lenders have varying requirements and may demand that a borrower submit a wide array of documentation, the following steps will give you a pretty good idea of what to expect.
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Call the Lender
You may need to make a half dozen phone calls before you find the person responsible for handling short sales. You do not want to talk to the "real estate short sale" or "work out" department, you want the supervisor's name, the name of the individual capable of making a decision.
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Submit Letter of Authorization
Lenders typically do not want to disclose any of your personal information without written authorization to do so. If you are working with a real estate agent, closing agent, title company or lawyer, you will receive better cooperation if you write a letter to the lender giving the lender permission to talk with those specific interested parties about your loan. The letter should include the following:
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Preliminary Net Sheet
This is an estimated closing statement that shows the sales price you expect to receive and all the costs of sale, unpaid loan balances, outstanding payments due and late fees, including real estate commissions, if any. Your closing agent or lawyer should be able to prepare this for you, if you do not know how to calculate any of these fees. If the bottom line shows cash to the seller, you will probably not need a short sale.
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Hardship Letter
The sadder, the better. This statement of facts describes how you got into this financial bind and makes a plea to the lender to accept less than full payment. Lenders are not inhumane and can understand if you lost your job, were hospitalized or a truck ran over your entire family, but lenders are not particularly empathetic to situations involving dishonesty or criminal behavior.
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Proof of Income and Assets
It is best to be truthful and honest about your financial situation and disclose assets. Lenders will want to know if you have savings accounts, money market accounts, stocks or bonds, negotiable instruments, cash or other real estate or anything of tangible value. Lenders are not in the charity business and often require assurance that the debtor cannot pay back any of the debt that it is forgiving.
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Copies of Bank Statements
If your bank statements reflect unaccountable deposits, large cash withdrawals or an unusual number of checks, it's probably a good idea to explain each of those line items to the lender. In addition, the lender might want you to account for each and every deposit so it can determine whether deposits will continue.
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Comparative Market Analysis
Sometimes markets decline and property values fall. If this is part of the reason that you cannot sell your home for enough to pay off the lender, this fact should be substantiated for the lender through a comparative market analysis (CMA). Your real estate agent can prepare a CMA for you, which will show prices of similar homes:
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Purchase Agreement & Listing AgreementWhen you reach an agreement to sell with a prospective purchaser, the lender will want a copy of the offer, along with a copy of your listing agreement. Be prepared for the lender to renegotiate commissions and to refuse to allow payment of certain items such as home protection plans or termite inspections.
Now, if everything goes well, the lender will approve your short sale. As part of the negotiation, you might ask that the lender not report adverse credit to the credit reporting agencies, but realize that the lender is under no obligation to accommodate this request.
Below is an actual case study of a short sale compared to the bank foreclosing and taking the property back as an REO. Notice, the bank loses $12,080 if they go ahead and foreclose on the property – and that doesn’t include the additional $8,775 in closing costs they will likely pay before they are done. In this case, the bank could save almost three times as much if they allow a short sale.
Read more about Before you Buy a Short Sale.
Click Here For Page Two About Short Sales
Tax Deferred Exchanges
Internal Revenue Code, Section 1031 provides that no gain or loss is recognized when business or investment property is exchanged for other business or investment property of like kind. A tax deferred exchange is one of the few methods available to defer income taxes on the sale of real property.
The advantage of a tax deferred exchange is that the taxpayer can sell income, investment or business property and replace it with like-kind property without having to pay federal income taxes on the transaction. There must be an actual exchange of property. A sale of property followed by a reinvestment of the proceeds does not qualify under Section 1031.
General Requirements
Business or Investment Property. The property sold (“relinquished property”) and the property received (“replacement property”) must both be held for productive use in a trade or business or for investment purposes.
Property Excluded. Neither property can be: stock in trade or other property held primarily for sale; stocks, bonds or notes; interests in partnerships; certificates of trust or beneficial interests; or choses in action.
Like-Kind Property. The relinquished property and the replacement property must be of “like kind.” Generally speaking, any real property exchanged for other real property should qualify as like kind. For example, an apartment house property can be exchanged for raw land.
Exchange. There must be an exchange of property, not a sale and a reinvestment of the proceeds in another property.
Types of Exchanges
A simultaneous or two party exchange is an exchange in which the relinquished property and the replacement property are exchanged on the same date, with each party swapping its property in exchange for the other party’s property. This type of exchange is not common in the real estate area.
A non-simultaneous or two party delayed exchange is an exchange in which the taxpayer closes on the sale of the relinquished property on one date, but does not close on the purchase of the replacement property until a later date. The exchange is not simultaneous or on the same day. This is sometimes referred to as a "Starker Exchange" after a Supreme Court case which ruled in the taxpayer's favor for a delayed exchange. A Starker Exchange is utilized where the taxpayer must close on the sale of the relinquished property but has not yet located or is not yet able to close on the purchase of the replacement property. This is the most common type of exchange in the real estate area.
A reverse exchange is an exchange in which the taxpayer needs or desires to close on the replacement property before he has found a buyer to buy his relinquished property. Generally an intermediary takes title to the replacement property and holds or “parks” the property until the taxpayer has sold the relinquished property. These are sometimes called “parking transactions.”
There are many ways to structure an exchange and with proper planning almost any transfer of real estate can be structured as an exchange. However, like-kind exchanges must be carefully planned with appropriate documentation and adherence to the applicable Code provisions and Regulations.
Special Rules for a Starker or Non-simultaneous Exchange
The most popular form of exchange is a non-simultaneous or Starker exchange in which the taxpayer closes on the sale of the relinquished property and at a later date closes on the purchase of the replacement property. Section 1031 and the applicable regulations permit Starker exchanges with the use of a qualified intermediary and set out the procedures which must be followed.
A taxpayer who wants to do a Starker exchange under Section 1031 will typically market his property just as he would without consideration of the exchange. A sales contract is signed which contains language requiring the buyer to cooperate with the taxpayer in the intended exchange. Prior to closing, the taxpayer enters into an exchange agreement with a qualified intermediary which permits the qualified intermediary to substitute for the taxpayer in accordance with the requirements of the Code and Regulations. Among other things, the exchange agreement contains provisions for:
An assignment of the taxpayer's contract to the qualified intermediary.
Payment of the proceeds of sale at closing to the qualified intermediary instead of to the taxpayer.
Deeding of the property directly by the taxpayer to the buyer.
After closing on the sale of the relinquished property, the taxpayer locates replacement property. There are special rules relating to the manner of identification of the replacement property, time limitations on identification and acquisition of replacement property, and the use of qualified intermediaries.
Identification Period. The taxpayer must either close on replacement property or identify the Replacement property within 45 days from the date of transfer of the relinquished property. This requirement is satisfied if replacement property is received before 45 days has expired. Otherwise, the identification must be made in writing signed by the taxpayer and hand-delivered, mailed, faxed, or otherwise sent to the Qualified Intermediary, or other persons named in the regulations. After 45 days have expired, it is not possible to designate any additional replacement properties.
Identification Notice. The identification notice must contain an unambiguous description of the replacement property. This includes, in the case of real property, the legal description, street address or a distinguishable name.
The taxpayer may identify more than one property as replacement property but the maximum number of replacement properties that the taxpayer can identify is (i) any three properties regardless of their market values (the 3-Property Rule); (ii) any number of properties as long as the aggregate fair market value of the replacement properties as of the end of the identification period does not exceed 200% of the fair market value of the relinquished property (the 200 Percent Rule); or (iii) any number of replacement properties but only if the taxpayer receives identified replacement property constituting at least 95% of the aggregate fair market value of all identified replacement properties (the 95% Rule).
Exchange Period. The replacement property must be received and the exchange completed no later than the earlier of 180 days after the transfer of the Relinquished property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was transferred. The replacement property received must be substantially the same as the property which was identified under the 45-day rule described above. There is no provision for extension of the 180 day period.
If an exchange commences late in the tax year, the 180-day exchange period can end later than the April 15 filing date of the taxpayer’s tax return. If the exchange is not complete by the time for filing the tax return, the taxpayer must obtain an extension of time to file. If the taxpayer does not obtain an extension, the exchange period will end on the due date of the return.
Qualified Intermediary
During the exchange period, the taxpayer must avoid actual or constructive receipt of money or other property from the sale of the replacement property. Any receipt of money or other property before the acquisition of the replacement property will disqualify the exchange. This means that the taxpayer may not receive cash in hand, nor may the taxpayer derive economic benefit from cash or other property held by an intermediary in an exchange escrow account. The funds in escrow cannot be pledged as security for a loan to the taxpayer.
Accordingly, at the closing on the sale of the relinquished property, a qualified intermediary (instead of the taxpayer) receives the cash proceeds and holds the proceeds in an escrow account for use in acquiring replacement property.
A qualified intermediary may not be the taxpayer or a “disqualified person.” The Regulations define a “disqualified person” as any “agent of the taxpayer”, meaning generally any employee, attorney, accountant, investment banker, real estate agent or broker who had such relationship with the taxpayer during the two year period leading up to the exchange, as well as family members.
The qualified intermediary enters into an exchange agreement with the taxpayer to acquire the relinquished property from the taxpayer, transfer the relinquished property to its buyer, acquire replacement property, and transfer the replacement property to the taxpayer. The qualified intermediary holds the proceeds from the sale of the relinquished property and applies the proceeds to the acquisition of the replacement property.
In practice, the taxpayer may enter into a contract to sell the relinquished property and thereafter assign the contract to the intermediary. The deed may pass directly from the taxpayer to the buyer. Similarly, the taxpayer may enter into a contract to purchase the replacement property. The contract is then assigned to the qualified intermediary, the seller is notified of the assignment, and the replacement property is deeded directly to the taxpayer.
The exchange agreement should clearly spell out the intention of the taxpayer to engage in a tax deferred exchange, the duties and obligations of the qualified intermediary, and limit the right of the taxpayer to receive money or other property held by the qualified intermediary.
Conclusion.
When an owner of real estate wants to dispose of one business or investment property and acquire another property, consideration should be given to structuring the transaction as a like-kind exchange under Section 1031. With careful planning and appropriate documentation, most transactions can be structured as exchanges. The savings realized by deferring taxes can be substantial. However, an exchange should not be undertaken without a thorough consideration of all alternatives and discussion with the taxpayer’s accountants, attorneys and tax advisers.
For further information or if you have any questions or comments regarding the issues presented, please do not hesitate to contact Robert W. Warfield (410) 544-1020 (rww@wmdlaw.com).
Disclaimer: This publication provides general information and is not intended to provide legal advice.The information presented should not be construed to be formal legal advice or the formation of a lawyer/client relationship. Persons accessing this site are encouraged to seek independent counsel for advice regarding their individual legal issues
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