Santa Comes to Homeowners in Foreclosure - Investors are Visited by the Grinch

President Bush signed legislation yesterday removing the 1099 Forgiveness of Debt issue hanging over the heads of homeowners in foreclosure. Previously if a homeowner was foreclosed on, or they did a short sale, the lender could issue a 1099 Forgiveness of Debt. This essentially said that the lender was forgiving the remaining debt that the homeowner owed. This change does not cover investment properties![googmonify]4494413162:right:250:250[/googmonify]

Considering that in California, some homeowners are upside down by $50-100,000 or more, and that the bank also adds the amount that they were behind, attorney’s fees and then sells the home at a loss to the total so this is a very significant help. These homeowners could have recieved these 1099’s at the end of the year and been forced to add that much income to their tax returns.

For example, a homeowner could be making $80,000 a year and paying taxes on that amount. They have a foreclosure and the bank issues a 1099 for $100,000. The former homeowner would owe ordinary income tax on $180,000 that year. There were a few exceptions to this provision noted below - but many people were going to be hit.

Investors however will not get the same relief. They must use one of the following provisions for relief. Investors will need to negotiate with the lender to not issue them a forgiveness of debt in a short sale or deed in lieu of foreclosure. Alternatively, they can qualify under the IRS provisions of a zero net worth or potentially be forced into a bankruptcy situation or have to work out a payment plan with the IRS.

I think this was a critical legislative item to pass and wish it had included investors as well. However, besides the relief it will provide for homeowners, it will also have one other significant consequence.

This will increase the number of foreclosures - especially in high value markets that are rapidly dropping in value. People that were hanging on because they could not afford the tax hit will now choose to walk. This will be an unintended consequence of this legislation.

Experts estimate that in 2008, one-third of the sales will be REO’s and 40% of the sales will be in some part of the foreclosure process. Important note, when a bank forecloses on a property that is counted as a sale. There are areas where one-third or more of the sales are actually propertes going to the bank. This is going to exert tremendous downward pressure on pricing, with a November 27 LA Times article surveying a number of economists about their predictions. Most of them were suggesting that a drop in the 15-25% range was probable, and one suggested 35% was more likely.

2008 and 2009 will be wild years for distressed market investors - are you ready?

Posted in  Real Estate