The Risk and Liability of Doing Short Sales

From a legal standpoint, short sales can be risky business. Many real estate brokers just refuse to do short sales and refer them instead. And while it may be tough to pass on a full commission, it may well be the wisest choice. Good brokers with good intentions can unknowingly cost their clients tens of thousands of dollars and expose them to future liability or tax issues. Lack of knowledge about the short sale process can leave brokers themselves severely exposed to expensive legal liability.

Here are some examples of short sale scenarios that can result in having a client file a complaint or lawsuit against you.

You overstep your boundaries when offering advice.

Most brokers are aware that they are prohibited from giving legal advice to buyers or sellers. But what constitutes legal advice?

Something as simple as telling your seller that a short sale is their best option can expose you to potential legal action. Maybe a loan modification would be in the client’s better interest. Maybe they are so buried in debt that they’d be better off filing bankruptcy. A legal or tax professional needs to review the alternatives with the seller. Brokers are not licensed as a legal or tax experts, and giving advice on these matters leaves you exposed to legal liability.

You don’t verify that the lender’s short sale agreement offers full satisfaction of your client’s mortgage debt.

The language lenders use regarding the deficiency can be very vague. It is critical that you verify with the lender exactly what their position is regarding future deficiency claims. If you mistakenly believe the lender is waiving any future deficiency claims and communicate that to your seller, you leave yourself wide open to a lawsuit if the lender pursues the deficiency at a later date.

You don’t keep current on legislation that affects short sales.

The Mortgage Forgiveness Debt Relief Act prevented homeowners who went through a short sale from being taxed on the amount of their mortgage debt that had been forgiven. That act expired at the end of 2013, so now debt that has been forgiven by a lender might count as taxable income. If you haven’t kept up with the continual changes in legislation such as this, your advice could cost your client tens of thousands of dollars. Dollars that they will want to recoup from you. (The good news: there are other tax-saving alternatives currently available for short sale sellers.)

You don’t know what you don’t know.

Every short sale is different, and every short sale is complex. They often have serious legal or tax issues. Here are a few short sale issues you may not even be aware of. Not knowing the ramifications could result in legal proceedings against you.

  • What figure should go on line 7 of a 1099-C and can it be negotiated?
  • How much in taxes will a seller owe on a potential 1099?
  • Would it be better to rent the property, even at a loss, rather than pay the 1099 taxable amount?
  • When is it better to sign a promissory note as opposed to accepting a possible deficiency judgment or 1099?
  • Was there a Truth-in-Lending violation by the lender that can be leverage in negotiations?
  • What happens if a seller gets both a 1099 and a deficiency judgment?
  • When should a seller consider bankruptcy? What type?
  • What actions can a seller take now to protect their assets if they’re later forced into bankruptcy by a deficiency judgment?
  • How can a seller structure a short sale to make sure they qualify for a Chapter 7 versus being forced into a Chapter 13?
  • What legal issues does a seller expose themselves to when having someone buy their short sale to then rent, lease-option, or contract to sell back to them?
  • Should a seller disclose a non-arm’s length short sale to their lender to avoid a future fraud lawsuit?
  • When can IRS Form 982 be used and how?
  • Will there be a capital gain issue in addition to a 1099 or deficiency judgment?
  • If the seller moves out of the property, how do you keep the lender from considering it abandoned and accelerating the foreclosure process?
  • What happens if a second lien holder discharges their mortgage security instrument, but enforces their promissory note and gets a judgment against the seller before the short sale closes?
  • Will a short sale lead a seller’s lender to investigate their mortgage application, and are there issues that could then lead to charges of fraud against the seller?
  • Will there be a state tax on any forgiven debt, even if seller qualifies for the federal exemption?
  • If the property is a condo, how should any past due association fees be handled?

As I said, short sales are complex. If you’d rather not take on the risk of doing a short sale, play it safe and refer the business. Washington Property Solutions pays a 30% referral fee. We provide your client with free attorney and CPA consultations. We do all the work, and you can free up the time to focus on building your core business. To refer your short sale, call Richard Eastern at (206) 612-5541.

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