Short Sales - Warning! You May Cause Your Client to Fail the Means Test

Services for Real Estate Pros with Law Offices of Louis J. Esbin

A recent email to a client follows, and should be a fair warning to have clients consult with bankruptcy counsel before execution of short sale purchase and sale documents:

  1. As a result of the short sale of your home before you file bankruptcy you will no longer have the contractually due amount owing to your first and second.
  2. As a result, when we calculate your eligibility for Chapter 7 relief (rather than Chapter 13 relief) we will not be able to deduct from your Annualized Monthly Income those monthly payments.
  3. As a further result, if your Annualized Monthly Income (calculated from the prior 6 months of payment advices) exceeds the Median Income for your 4 member household (currently $79,971) you will not "pass" the Means Test, meaning that you will be forced into a 5 year Chapter 13 repayment plan; and to add insult to injury you will only be repaying your debts without the benefit of saving your home.
  4. Rent does not reduce your Annualized Monthly Income for purposes of calculating the Means Test.
  5. Remember that the short sale does not monetarily benefit you (you will still have liability for the deficiency owing on the second), and yet the inability to claim the contractually due amounts (even if not being paid) will cause you greater harm because you cannot gain a Chapter 7 discharge, but must wait out a Chapter 13 discharge.
  6. The short sale, although delayed, can happen any time after you receive your Chapter 7 discharge. This would be a win-win for you and the Realtor.

Louis J. Esbin, Esq.
Law Offices of Louis J. Esbin
27201 Tourney Road, Suite 122, Valencia, CA  91355-1857
Tel: 661-254-5050 | Fax: 661-254-5252 | Web:
Certified Bankruptcy Specialist - State Bar of California Board of Legal Specialization.

Comments (32)

James Lyon
Vista Pacific Realty - Sacramento, CA

Thanks for the post and informing us of these rules. More knowledge makes us better.

Dec 18, 2009 08:16 AM
Josh Holt
RE/MAX Coast To Coast~ Dedicated to You! - Berwick, ME
Southern Maine and NH Real Estate - Your Source of Info on the Berwicks

Louis, what great info. There are very few bankruptcy attornies in our area. While I never give out legal advise, knowing this information will benefit my clients. Thanks for sharing.

Dec 18, 2009 08:20 AM
Bill Gillhespy
16 Sunview Blvd - Fort Myers Beach, FL
Fort Myers Beach Realtor, Fort Myers Beach Agent - Homes & Condos

Evening Louis,  We agents need a reminder like this to stay away from giving legal advice and trying to be helpful in areas outside of Real Estate.   Hope your Holiday Season is the best ever !

Dec 18, 2009 09:00 AM
Christa LaFarlette (la-far-let)
Your Choice Real Estate - Orange Park, FL

Thank you for the post!  I always tell my customer that I am not licensed to practice law, and would be dangerous giving opinion on accounting---and as such they should consult a professional.  Additionally, I have been doing most of my short sale closings through a local real estate attorney, who in turn will do  phone consultations for my short sale customers.  It benefits him in that I am continually loyal, and myself in that the sellers and myself get counsel.

Good stuff---!

Dec 18, 2009 10:26 AM
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

I need to re-blog this one.  Even if the laws are slightly different from state to state, it is a reminder to get the whole picture in focus before taking action. 

Dec 18, 2009 10:50 AM
Nick Snow
North Port, FL

Interesting. I had a client simply walk away from their home and let it go into foreclosure, at the advice of their bankruptcy attorney, instead of attempting any sort of short sale. I was blown away!

Dec 18, 2009 11:29 AM
Elizabeth Weintraub Sacramento Broker
Elizabeth Anne Weintraub, Broker - Sacramento, CA
Put 40 years of experience to work for you

This is for Michael in comment #4. There are no deficiency judgments in California on purchase money loans under a trustee's sale. But there are ways to obtain a deficiency otherwise, which primarily applies to hard-money seconds when the second loses it security for the loan. Not only could there be a deficiency, but if the proceeds of that hard-money loan were not used to improve the home, the seller might also be subject to income tax.

Dec 18, 2009 11:57 AM
Nathan Tutas
Tutas Towne Realty, Inc. - Davenport, FL
Your Central Florida Real Estate Expert

How sad is this situation. The banks convince congress to pass new legislation making bankruptcy a payment plan rather than a foregiveness of debt. Then they make bad decisions and take risks they shouldn't and cause the financial collapse of a whole country. Then they convince the president to pay them stimulus money instead of the American public. Sounds like I need to start a bank. Unbelievable!!!

Dec 18, 2009 12:30 PM
Ray Spitler
Keller Williams Realty - Plymouth, MI

I have heard mixed opinion on the benefit of including your home in a BK.

Can you tell us what good it does to include your home when the bank can simply appeal it and have the home later removed and foreclose anyway? Or am I mis-informed?

Dec 18, 2009 01:02 PM
Michael Cole
CPG Tours - Corona, CA

Hi Elizabeth: Thanks for the additional info. I appreciate it. Yeah, people not knowing they could get hit with a deficiency judgment, or even just the tax liability, could be financially devastating for them.

Dec 18, 2009 09:58 PM
Clayton Bonjean
Mainsail Realty Company - Santa Rosa Beach, FL
Broker | Owner | MBA

Great point.  This is exactly why all agents should ask their client to consult an accountant and attorney.   As a CDPE we have a hold harmless agreement that states this.

Dec 19, 2009 01:20 AM
Beverly of Bev & Bob Meaux
Keller Williams Suburban Realty - West Orange, NJ
Where Buying & Selling Works

Louis, thanks for this. Good points and reminders. It's scary how one action or two can cause enormous problems for homeowners. I'm waiting to see the lawsuits from owenrs who think they've been wronged by an attorney or agent when 3-5 years passes and banks start evoking the recourse that may be available and go after the balance.

Dec 19, 2009 05:02 AM
Scott Taylor
Realty Center - Orlando - Ocoee - Orlando, FL

I had a seller (not my listing) file for bankruptcy after they had signed a short sale contract with my buyer, It held it up for months and months.

Dec 19, 2009 01:16 PM
Christine Donovan
Donovan Blatt Realty - Costa Mesa, CA
Broker/Attorney 714-319-9751 DRE01267479 - Costa M

This is important information for everybody to consider when looking at both a short sale and a bankruptcy to make sure they're making the right decision.

Dec 19, 2009 03:41 PM
Louis Esbin
Law Offices of Louis J. Esbin - Santa Clarita, CA

Thank you everyone for the overwhelming response.  Let me see if I can address some issues:

In response to Michael (Comment No. 22):  Clients should always seek the advice of their tax professional to assess the potential tax liabilities arising the sale of properties.  Those liabilities can be daunting to people who have little or nothing left to show for years of what they thought would be retirement investments in real properties.

In response to Ray (Comment No. 21):  Clients must make disclosures of all real and personal property wherever located and whatever interest they may have.  As well there must be complete disclosure of all creditors, whether secured, unsecured, tax, or other, including those that are disputed, unliquidated, contingent or unmatured (every rock should be unturned to find creditors).  As well, all income from whatever sources and expenses of all types are among the disclosures required.  Anyone who advises you or a client that they do not need to make these disclosures is not doing you or the client a good service.  At the meeting of creditors the client will be faced with a sign that telling them that the FBI investigage Bankruptcy Fraud, so when the trustee asks whether they made full disclosure and they fess up they did not, the finger will be pointed to you or the attorney or other person that advised them they did not need to a full disclosure.

In response to Christa (Comment No. 16) and Nestor and Katerina (Comment No. 11):  My office offers a 45 minute consultation at $100 that includes consulting with them about short sales, foreclosures and bankruptcy.  When we confirm the consultation we email them a questionnaire that asks for real and personal property, income, expense, and credit card disclosures.  We encourage the short sale as an alternative whenever possible, and always send them back to the realtor from whom they were referred, and also encourage them to seek tax advice.  The consultation fee is applied to the retainer if we are retained.  It's a Win-Win for everyone.

In response to Lenn (Comment No. 2):  When I explain the Means Test to client I tell them that it does not stand for it being a mean spirited test, but rather the client has the means and ability to pay their creditors back over a period of 3 to 5 years.  The Means Test, though, discriminates in its treatment between those who rent and those who own; those who have secured debt and those who don't.  It is this discriminatory treatment and the draconian result that led me to post the blog.

Thank you so very much, all, for your support and continuing interest.  Happy Holidays and Hopes for a Prosperous and Debt Free New Year.  "Debt Free Again in 2010!"

Lou Esbin

Dec 20, 2009 03:38 AM
Martin E. Kalisker, Esq.
Natick, MA
Real Estate Law From A Practical Perspective

Your email response is a perfect example of why a competent Realtor will always insist that a competent lawyer, knowledgeable and a practicing member of the State real estate, bankruptcy and/or estates and trust bar, be advising you on a short sale or any other transaction that relates to your rights, obligations or finances in a real estate transaction.

I will not associate with a customer that has a  "do it yourself" attitude about short sales.  Banks and lenders are victim of your loss, too.  And I guarantee that they have their legal counsel looking only at one thing - how to protect the bank or lender's rights.  They couldn't care less if you file Chapter 7 or 13.  But you should.

Dec 21, 2009 03:29 AM
Louis Esbin
Law Offices of Louis J. Esbin - Santa Clarita, CA


Thank you!

In California, unlike so many other states, attorneys do not close real estate transactions (save larger commercial deals) and so, sellers and buyers are not accustomed to hiring counsel to advise them on short sales or other residential real estate transactions.  And, so, it is up to California Realtors to encourage retention of counsel to advise clients on short sales; at least on a consultation basis such as we offer. 

Lou Esbin

Law Offices of Louis J. Esbin 
27201 Tourney Road, Suite 122, Valencia, CA  91355-1857 
Tel: 661-254-5050 | Fax: 661-254-5252 | Web: 
Certified Bankruptcy Specialist - State Bar of California Board of Legal Specialization

Dec 21, 2009 06:25 PM
Dan Haggerty

very good info here thank you

Dec 22, 2009 11:07 AM
Jennifer Getz

In #5 you say "you will still have liability for the deficiency owing on the second". If it is an owner occupied, purchase money second, or any type of non-recourse loan, it was my understanding that the seller will not have liability for the deficiency?

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