April 29, 2010

Short Sales Going Rogue!!!

Ok . . . so . . . apparently, a few local governments don't believe they're getting a big enough piece of the pie when it comes to short sales.  Ergo, they've decided that buyers and sellers should fork over more money in the form of higher transfer and recordation taxes.  Huh?!!

Before I go on, a few definitions are in order:

Short sale
In the real estate industry, a short sale is the sale of a property in which the fair market value is less than the outstanding loan balance and the lender agrees to accept, as payment in full, less than what is owed.

Consideration
Merriam-Webster's Dictionary of Law defines consideration as: something (as an act or forbearance or the promise thereof) done or given by one party for the act or promise of another.  It is one of the elements necessary to create a contract (the other two elements are offer and acceptance). No consideration. No contract. In laymen's terms, consideration is what you give up (e.g., cash) or are relieved of (e.g., debt forgiven) or a combination of both, in order to make the deal happen. In regular home sales, the consideration is, generally, the contract sales price.

Ok . . . so here's what's going on: 

Normally, when a property is sold, unless there is an exemption, counties collect transfer and recordation taxes. The taxes are calculated on the "consideration payable."  Traditionally, transfer and recordation taxes are calculated based on the sales price. 
In short sales, this means less tax is collected because of the "short" price. 

Recently, however, Anne Arundel County started calculating transfer and recordation taxes on the amount of the outstanding debt (i.e., seller's loan balance).  And Montgomery County is considering doing the same.  They have said that if the lender pursues the seller for the deficiency, taxes will be calculated on the short sale price. If, however, the lender waives the deficiency, taxes will be calculated on the outstanding loan balance. This has caused an uproar because it could mean hundreds or thousands of dollars more.

Lemme give you an example:

Contract Sales Price:  $250,000
Seller's Outstanding Mortgage/Deed of Trust: $350,000
Deficiency: $100,000
□ If the lender pursues the seller for the deficiency, taxes will be computed on the contract sales price of $250,000.
□ If the lender waives the deficiency, taxes will be computed on the outstanding debt of $350,000.
□ If there are two loans, whatever is waived is added to the contract sales price to calculate transfer and recordation taxes.

So . . . what does this really mean?
This means that even after the short sale has been approved (which likely took months) it may be delayed even further.  It also means the deed will not be recorded unless someone pays the additional taxes. Likely, this obligation will fall upon the buyer and seller who normally split the taxes.  The problem is that the seller is already in a hardship situation and the buyer is not going to want to pay taxes on an amount he/she did not bargain for.  And if the issue arises at the last minute (e.g., settlement), it may mean that realtors agree to reduce their commissions in order to get the deal done.  Under any scenario, no one will be a happy camper.

What gives counties the right to do this?
Under the Tax - Property Article of Maryland, transfer and recordation taxes are computed as a percentage of consideration payable.  Under Maryland case law, the "consideration payable" includes the amount of any "outstanding debt when the property is conveyed subject to a mortgage or deed of trust, whether or not the buyer expressly "assumes" the obligation."   Pritchett v. Kidwell, 461 A.2d 57 (1983). 

What will counties require?
In order to determine whether the debtor is still on the hook for the amount over and above the short sale price, counties may require one or all of the following: (1) a copy of the short sale approval letter (which should state whether the account is considered paid in full); (2) a copy of the most recent mortgage statement; or (3) a payoff statement. 

What should realtors do?
At a minimum: (1) inform buyers and sellers; (2) determine the amount of the unpaid principal balance; (3) negotiate who will pay the additional taxes and include language in the sales contract.

What should title companies do?
Unless the county has said it will collect only on the short sale price, collect taxes based upon the amount of the outstanding debt.  If it's determined later that taxes were overpaid, buyers and sellers can apply for a refund.

What should lenders do?
Lenders financing the buyer's loan should be afraid . . . very afraid.  Under the new RESPA rules, transfer taxes on the GFE cannot be higher on the HUD1.  Lenders should be notified in advance whether the buyer will have to pay transfer taxes on the forgiven debt.  Then on the GFE list transfer taxes based upon the higher amount.

What are some of the implications of the new policy?
□ Under the new RESPA rules, any change in transfer taxes at settlement would be considered a "changed circumstance" and would delay settlement.
□ Many people in the industry believe that other counties will jump on the bandwagon.
□ The Associated Press reported that there were 16,788 foreclosure filings - which include notices of default, foreclosure sales and lender purchases of foreclosed properties - in the final quarter of 2009.  The figure represents a six percent increase over the same period in 2008.   Currently, "Maryland has the 10th highest foreclosure rate in the country for the quarter."  Under this method of collecting transfer and recordation taxes, Maryland's property foreclosure rate may climb even higher.

Who's making the case that things should remain "as is"?
The Maryland Association of Realtors, the Maryland State Bar Association, Maryland Land Title Association, Maryland attorney general's office, and other interested parties are working to resolve this matter.

Posted by: shana@lakeviewtitle.com  (Don't hate the messenger!!)