New Law on Short Sale - What you Should Know to Protect Yourself

Effective July 15, 2011, California Code of Civil Procedure (“CCP”) 580(e) was amended to prohibit a deficiency judgment on any loan secured solely by a deed of trust on a 1-4 unit dwelling sold in a short sale.  Enough legal jargon…what exactly does this mean and how does apply to you?

First, it means that if your lenders agree to a short sale, it will release you from your personal liability on loans secured solely by a deed of trust against a dwelling of 1- 4 units.  If the lenders want the short sale to go through, they will have to be satisfied with the proceeds from the sale.  The banks can no longer demand that borrowers sign promissory notes… AND no more tricking borrowers into believing that releasing of the lien was in fact releasing their personal liability.  The lenders do not have to agree to the short sale, but if they agree, they cannot come after you once the short sale is completed.  However, if you think this is too good to be true…you’re right. Keep reading!

Second, there is no requirement for a release of personal liability on anything other than a consensual lien i.e. no requirement to release judgment lien or liens placed on the property such as by a homeowners association or taxing authority.  These parties do not have to agree to accept the proceeds from the sale as payment in full. The forgiveness of personal liability also does not apply to borrowers who are corporations, limited liability companies, limited partnership or political subdivision of the state.  In addition, it also does not prohibit the lender from obtaining a judgment for fraud with respect to the short sale or waste committed to the property.

Third, CCP 580(e) does not release you from any tax liability.  Remember, every short sale has tax implications. The IRS/State Franchise Tax Board wants to know two things: 1) Did you make any money on the deal and 2) Did you borrow any money which was not repaid?  If you made money on the deal, including taking out cash to buy another house, car, pay off credit card, you may have a gain. If you borrowed money which was not repaid, you will have Cancellation of Debt Income (“CODI”).  CODI will be taxable to you at your current tax rate unless an exception applies. Make sure you know all the tax implications before the short sale is completed.  If there is CODI, it can be discharged in bankruptcy, but only if the bankruptcy is filed prior to the short sale being completed.

In conclusion, CCP 580(e) is a mixed bag for consumers.  It may help reduce personal liability while increasing tax liability.  There is no question that this new law is going to hurt the lenders and help the IRS and State Franchise Tax Board.  This will be found money for the tax man.  Borrowers will see the forgiveness of personal liability and completely disregard the tax consequences.   Don’t be one of those people!  If you are considering a short sale, seek legal advice prior to starting the short sale process.  This is a complicated area of the law, but a bankruptcy or real estate attorney should be able to make to an analysis of your particular situation fairly quickly.   I see people for a FREE 30 minute consultations at my offices located in Walnut Creek, Antioch and Brentwood.

THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A VOLUNTARY DEFAULT, SHORT SALE, FORECLOSURE OR BANKRUPTCY.  THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.         GRIMESBKLAW.COM  (925) 323-7772     

© 2011 Joan Grimes