TO SHORT SELL OR NOT TO SHORT SELL?

Clients frequently ask me whether they should short-sell property or not.  My answer is that one should consider a short sale within the context of a bankruptcy.  I DO NOT THINK ONE SHOULD SHORT SELL PROPERTY WITHOUT CONSULTING WITH COUNSEL. 

Case in point, recently I met a client who short sold his residence because it was substantially underwater.  He had first and second deeds of trust and had consulted with a real estate agent specializing in short sales.  The client sold the property, but did not receive a release from the second deed of trust holder.  When I met the client, he was being sued by the second trust lender.  This has happened time and time again. 

I would have advised the client differently.  If he could have short sold the property with a release from the second trust lender or for a small payment to that lender, then I would have blessed the transaction.  If not, then bankruptcy is a consideration among other factors.

Credit Consequences

I have continued to monitor on-line publications from Freddie Mac, Fannie Mae and FHA concerning the consequences of a short sale or bankruptcy.  While a short sale may be equivalent to a material adverse credit event or a chapter 13 bankruptcy filing, it has a less dramatic impact on credit scores than judgment liens, a foreclosure or a chapter 7 filing.  Using a dart board, the biggest impact on credit score would be a foreclosure, then the entry of judgment liens against the debtor, then a chapter 7 filing, then a deed in lieu of foreclosure, then a short sale and in the center of the bull's eye would be a chapter 13 filing or voluntary debt resolution (if the latter works).  The center of the bull's eye represents the smallest impact on credit, around 150 points on the FICO score.  Hence, the best way to preserve your credit score would be to file a chapter 13 and to short sell a property during the bankruptcy.

Bankruptcy

If the above client had qualified for bankruptcy, I would have advised the client to remain in the house and file.  The client could have stated his intention on his bankruptcy filings that he wanted to retain the property and continue to pay.  In such an event, he would have been relieved of his obligation to pay on the second deed of trust.  After the bankruptcy, the client could have short sold the property without the threat of a lawsuit by the second trust lender.  In a Chapter 7, the underwater property could have been abandoned.  In addition, the administration of a chapter 7 case is relatively brief.  In a chapter 13, the court may have granted permission to short sell the property.  The court will not approve a short sell over the objections of a lender, but if the chapter 13 trustee will otherwise endorse the order, then the court will let the sale go through. 

Tax Considerations
We expressly do not give tax advice.  However, one should be aware that a short sale, foreclosure or surrender of a primary residence (upon the expiration of a patch Congress passed in 2008) or of an investment property can result in the realization of taxable income.  Sometimes, a taxpayers' basis in property will be so low that even in the event of a foreclosure, the disposition of the property results in capital gains.  Moreover, if the lender foregives some of the debt, the taxpayer may have phantom income known as "discharge of indebtedness income."  The short sale, surrender or foreclosure of investment properties in highly inflated markets, such as Florida, Arizona or California, may result in the realization of substantial discharge of indebtedness income.  According to the Internal Revenue Code, a bankruptcy filing offers an exception to the discharge of indebtedness rule. 

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

ATTORNEY OBLIGATION TO DISCLOSE ASSETS TO COURT

An issue recently arose concerning an attorney's obligation to disclose to the bankruptcy estate that a client's parent died leaving her an inheritance within 180 days from the filing of the bankruptcy.  See a prior blog article.  11 U.S.C. section 541 provides:

Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date—

(A) by bequest, devise, or inheritance;
. . .

(C) as a beneficiary of a life insurance policy or of a death benefit plan.

We concluded under the applicable Rules of Professional Conduct, Va. Sup. Ct. Rules, Pt. 6, Sec 11, Rule 1:6, that we must disclose such an event to the court because (i) our failure to do so would result in a fraud upon the court, unless we immediately withdrew from representation, and (ii) the failure to turn over assets of the bankruptcy estate would amount to bankruptcy crime.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

CREDITORS MEETINGS

A creditors' meeting provides a creditors and the bankruptcy trustee with the opportunity to examine you under oath concerning your bankruptcy petition.  The proceeding is recorded by the United States Trustees office, and the statements you make are given under oath and penalty of perjury.  In Richmond, the proceedings take place in the federal Counthouse for the Eastern District of Virginia. You may not bring a cell phone into the building.  Also the marshall's service will not allow you to place your cell phone in a locker.  DO NOT BRING A CELL PHONE to the creditors meeting in Richmond.  It is very important that you give any requested documents to our office in a timely manner.  The Trustee's office wants to receive documents a week before the hearing so that the trustee and the attorneys and staff at the United States Trustee's Office have a chance to review the documentation before the meeting.  At the meeting you will be required to fill out an interrogatory form.  Except for issues concerning your statement of intention this form is not too difficult.  Clients never get the statement of intention question correct.  In the bankruptcy petition, the statement of intention is an statement by you concerning how you want to handle secured debts appearing on Schedule D and any leases appearing on Schedule G.  Frequently, clients affirm that automobile loans and mark retain and continue to pay for secured loans on real estate.  This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.