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Fridays' FYI: What is a Deed in Lieu of Foreclosure?

By
Services for Real Estate Pros with S.P.O.C.H. a 501c3 Charitable NP

Each Fridays' Blog will provide (hopefully) useful information regarding the preforeclosure, and foreclosure process. NJ is a judicial foreclosure state.  Your state's laws, customs, and practices may differ. I'm not an attorney, and this isn't intended to be anything other than my opinion.

Shortly after a (NJ) homeowner misses the third, consecutive, monthly mortgage loan payment, he or she may receive from the mortgagee what's known as a Letter Of Intent (to foreclose).  I say may because a bankruptcy petition can impede the lender's collection process.  This LOI is the lender's first step in the implementation of a formal foreclosure proceeding. (next Fridays' FYI: What is a Letter of Intent?) Sometimes, the Borrower is encouraged to contact the lender to discuss a list of non-foreclosure alternatives including, but not limited to a  Deed in Lieu of Foreclosure, or, DIL.

What is a DIL?  According to the glossary (Short Sales, An Ethical Approach):

A Deed In Lieu of Foreclosure is used by a homeowner to voluntarily convey the title of his/her property to the mortgagee/beneficiary (lender) to avoid the negative credit consequences of a foreclosure. Lenders are generally reluctant to accept a DIL unless title is free and clear of any other encumbrances junior to theirs and the owners execute an estoppel affidavit acknowledging they are acting voluntarily, with informed consent.

Why would a lender accept a DIL?  By accepting a DIL, the lender doesn't have to go through a lengthy and expensive foreclosure process which, in NJ, can take from 8 to 18 months.

A borrower would benefit, too, because a DIL is usually given to the lender in exchange for the lender releasing the borrower from a deficiency judgment.

In my experience, DESPITE what is implied by the lender in its list of non foreclosure alternatives, lenders rarely agree to accept a DIL, but instead require a homeowner first try to sell the property utilizing the services of a licensed real estate broker.  If anticipated proceeds from sale aren't adequate to satisfy the mortgage(s), lenders will usually favor a preforeclosure short sale to accepting a DIL.

So, when your prospective listing Client tells you they will avoid foreclosure by simply deeding the house back to the bank... you can tell them it's your understanding from good authority that lenders rarely accept them, and to contact our office.  We'll give them the straight poop on Deeds in Lieu, and other conventionally accepted non foreclosure alternatives.  Then, get ready to take the listing!

SPOCH, a non profit organization, offers preforeclosure and preforeclosure short sale transaction support anywhere in the USA.

 

 

 

Comments (8)

Robert McArtor
RE/MAX Components - Fallston Maryland - Bel Air, MD
Top Listing Agent for Baltimore and Harford County

Great post. Should be on an Investors Forum however. HHmmmm.

Robert B. McArtor, REALTOR, Auctioneer http://www.MarylandsHomeTeam.com/

 

Feb 25, 2007 01:45 PM
Christopher Sevick
Sevick Law PLLC - Ann Arbor, MI
Real Estate Attorney
I agree that a DIL is not a magic solution.  First try to market the home properly and keep records of the comps and your prices.  Many times you can do a short sale before a DIL since the lender does not want any more inventory that they then have to price and try to sell.  However, remember that a short sale will result in a 1099 from the lender for taxes to be paid on the forgiven debt.  Probably 80% of the people that I discuss a short sale with don't know that.  But, in most cases a tax bill next year is better than a loan of 4-5 times more that can't be paid.  
Mar 09, 2007 02:00 PM
David Petrovich
S.P.O.C.H. a 501c3 Charitable NP - Oakhurst, NJ

"However, remember that a short sale will result in a 1099 from the lender for taxes to be paid on the forgiven debt."   Thanks for the comment, Christopher.  Your dual role as an attorney and real estate broker should keep your services in high demand.

While the tax issue is largely ignored,  the 80% of the people I speak with who do know about possible tax consequences arising from forgiven debt do not realize the "income" is probably exempt from tax. Due to the circumstances under which a mortgagee would ordinarily accept a DIL or short sale, most forgiven debt is considered partially, or wholly exempt from tax.

The problem many 'short sellers' encounter is with their mistaken belief that if the mortgagee doesn't issue an IRS form 1099, there is no tax consequence.  So much unnecessary noise is made about whether or not the lender will or will not issue a 1099 ... as if the lender decides what constitutes a tax event.  The seller is always responsible for reporting the "income" whether the lender issues a 1099, or does not issue one.

Even though in the majority of DIL or short sale scenarios the 'income' may and will likely be considered exempt from tax (see hardship, insolvency, and IRS form 982) it is the failure to report and treat which can result in fines, penalties, and additional interest.

Our non profit org assists former short salers unravel their IRS problems related to unreported income which oftentimes is exposed well after the fact... can you say "audit" when the lender finally gets around to issuing the  1099.

Two months ago, a woman came to us who sold short and had been UNNECESSARILY paying the IRS on an installment plan since her short sale....

Not only were we able to amend her previous tax return, her tax obligation was erased, and the money she had paid the IRS was returned to her.

We cover this, and much, much more, in our segment, "Overcoming Objectives" in our

                                                    Preforeclosure Lsting Workshop

 

 

Mar 09, 2007 10:25 PM
Christopher Sevick
Sevick Law PLLC - Ann Arbor, MI
Real Estate Attorney

David,

There is in fact truth in what you said.  I was being perhaps a little local in my comments.  With our inventory in Michigan and our poor economy we are seeing some lenders that will do a DIL in a little as two late payments if the agent/owner can show that home has been marketed correctly and documentation has been provided.  

I spoke to a lady yesterday who is looking at it, just missed her March payment (so she isn't late yet), but has marketed her home for almost a year with a Realtor, at a FMV price, and she and her husband are moving to Asia on a job relocation in a few months.  Presented correctly it is a great DIL situation for the bank since they get a well cared for home (pictures were provided) in prime season and not a dime in foreclosure costs.  Only another two months or so will tell if that DIL actually goes but it looks favorable now and she is setting the lender up with the facts and information very early.. 

It can not be stressed enough however to have a WRITTEN agreement with the lender as to how any actions will be reported to credit bureaus, taxing authorities and others.  Several times I have spoken to people who had "agreements" with lenders that were not written and found a foreclosure on their credit report or received a 1099 for different than what was understood.  Written is the only way to do it, and of course, followup and check to make sure it is reported as agreed.  The home being transferred in ownership is not the end of the process, but most people I believe stop there since the stress is gone. 

As for the 1099 that people don't receive I couldn't agree more.  It is THEIR responsibility to make sure that they correctly report the "income" on their taxes.  The 1099 is often missing so I always go back to the written agreement in the paragraph above and use those figures as a "substitute" 1099 for filing.  I think for many lenders this DIL/Foreclosure/Short Sale has come on quickly over the last few years and they simply don't have a good system to track and report these so that the 1099 results.  Of course there is also that issues that the former home is the most likely address they have and that if quite often where I assume the 1099 went.  In many cases I can only assume that no change of address was filed to avoid the other forwarded mail from other creditors as well.   

 

Mar 10, 2007 12:03 AM
David Petrovich
S.P.O.C.H. a 501c3 Charitable NP - Oakhurst, NJ
Thanks for, and I appreciate your comments. Feel free to visit anytime. 
Mar 10, 2007 12:41 AM
Jared Hokanson
Hokanson Realty & Jared Realty Group - Medford, OR
Your Home Sold, GUARANTEED!*
Just an FYI, in talking to many lenders who are in the process of foreclosing, if they do take a DIL, most will still end up going through the complete foreclosure process to guarantee that they have a clean title with no other encumbrances.
Jul 11, 2007 05:08 PM
Anonymous
Luis F

The pahantom TAX relief was signed into law and it is effective till 2009.

http://myflrealtor.wordpress.com/2008/01/03/phantom-tax-relief-bill-signed-into-law/

 

 

Sep 08, 2008 04:51 AM
#7
Anonymous
Jim Wilkins

On 28 Dec 2009, our mortgage bank executed, at our request, a Deed In Lieu on our second home in Florida. At the time of the DIL, we owed $530k on the home, and it was only appraised at $200k. We received a 1099-A from the bank indicating a Block 2 "Balance of Principal Remaining" of $330k. We have not received a 1099-C. Questions: (1) Why did we receive a 1099-A? (2) Should we expect to receive a 1099-C? If so, when? (3) If we never receive a 1099-C, and only have a 1099-A, what are the tax implications?

Apr 07, 2010 03:46 PM
#8