By Steven R. Neuner, Neuner and Ventura LLP, Marlton, NJ
People facing foreclosure have a lot of issues and concerns. They are especially in need of advice. This article will cover three topics: (1) liability if the property is vacated before delivery of the Sheriff’s deed; (2) risks of possible deficiency liability; and (3) a quick but not dispositive discussion of some possible tax liabilities. These are all important to deciding whether to do a short sale or deed in lieu of foreclosure, file for bankruptcy, or ride it out to the Sheriff’s sale.
Recent statistics show that the average time to Sheriff’s sale is almost three years. With a large backlog of existing foreclosures, this is not likely to change soon, although some indications suggest it might at some future date.
Moving out of the property before the Sheriff’s deed or other transfer of title may be ill advised for several reasons. First, the homeowner remains liable for any damage to person or property caused by or on the property until title is transferred. And liability for condominium or homeowner association dues continues. Even a Chapter 7 bankruptcy discharge normally only eliminates personal liability for monies owed when the bankruptcy was filed, leaving subsequent dues and charges still to be paid until the homeowner no longer has title. 11 U.S.C. 523(a)(16). But see 11 U.S.C. 727(b) and 328(a). In Chapter 13 the result is usually the same. See 11 U.S.C. 1328(d). Once a property is vacant, most homeowners insurance policies no longer provide coverage and require the homeowner to give notice the property is vacant. The cost of insuring a vacant property is much higher.
Another problem after a property is vacated is the cost and obligation of upkeep, but here some relief for the homeowner is available. N.J.S.A. 46:10B-51(b) provides that if a property in foreclosure is vacated or abandoned, and “prior to vesting of title in the creditor or any other third party… the property is found to be a nuisance or in violation of any applicable State or local code, the local public officer , municipal clerk, or other authorized municipal official shall notify the creditor, which shall have the responsibility to abate the nuisance or correct the violation in the same manner and to the same extent as the title owner of the property, to such standard or specification as may be required by State law or municipal ordinance.” In this situation, the homeowner’s attorney should notify the mortgage lender or counsel and the municipality in writing that the property is vacated.
Liability for deficiencies on the foreclosed mortgage is yet another concern. A bankruptcy discharge will eliminate personal liability, but even without such a discharge protections are available. Where all the following are true, the mortgage lender must start and complete a foreclosure before filing suit against the borrower personally on any deficiency, N.J.S.A. 2A:50-2; 2A:50-2.3:
1. The mortgage debt being foreclosed was not incurred for a business or commercial purpose;
2. The property is a 1, 2, 3 or 4 family residential property occupied by borrower or immediate family when foreclosure commenced;
3. The mortgage is the primary security for the debt;
4. The mortgage is not subject to a prior mortgage held by an unrelated third party,
In this situation any action on the deficiency is available to the first mortgage holder only for a limited time. Such actions are time barred if not filed within 3 months of the foreclosure sale, and can only be filed against those who were named as defendants in the foreclosure action Id. This time deadline only applies to completed sales approved by “appropriate legal sanction”. Wooten v Pollock, 116 N.J. Eq. 490,491 (Ch 1934). Therefore, a short sale or a deed in lieu of foreclosure would not qualify.
Such deficiency actions are rare. Part of the reason may be because filing even a timely deficiency suit against the borrowers personally reopens the foreclosure and sale. Under N.J.S.A. 2A:50-4, once a deficiency judgment is obtained, the borrower has another 6 months to redeem and get the property back by paying the amount of the judgment, plus interest and costs. Needless to say, this creates title problems for the purchaser at the foreclosure sale.
Having said this, there are some important caveats and strategic considerations. Holders of junior mortgages who are unrelated to the foreclosing first mortgage lender are not subject to the above limitations, and can sue the borrower personally right away. However, assuming the junior mortgage lien is extinguished by the first mortgage foreclosure sale, the junior lienholder has to file suit on the deficiency within one year of the sale or its confirmation. N.J.S.A. 2A:50-8.
More importantly, the protections described above do not apply if the property is not occupied by the borrower when the foreclosure is commenced. So moving out too early is not wise.
A final consideration, and a frequently overlooked potential “landmine” in these situations, is the possibility of a borrower who has not had her debts discharged in bankruptcy incurring “debt discharge income ” tax liabilities on a foreclosure sale, short sale or deed in lieu of foreclosure, where the lender is cancels the deficiency either by agreement or as a matter of policy, or because of successful application of a statute of limitations defense. Whenever a valid debt is “canceled” under these circumstances without full payment, the lender is required to issue a 1099-C stating the amount of the debt that is discharged, http://www.irs.gov/pub/irs-pdf/i1099ac.pdf. Unless one of several rules and exceptions apply, the debt becomes ordinary income taxed to the borrower the same as a cash payment received when the debt was discharged. There are protections for homeowners in foreclosures and mortgage modifications but the rules and exceptions are complex. See publication 4681, “Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) for the IRS explanation: http://www.irs.gov/pub/irs-prior/p4681–2010.pdf. Attorneys are well advised to bring up this potential issue and make sure the client knows to get competent tax advice.
Facing foreclosure involves a lot of difficult choices and options. Staying put or moving? Bankruptcy or an alternative? This article highlights some of the many considerations that come into play.
About the Author
Steven R. Neuner is Board Certified as a Business Bankruptcy Specialist by the American Board of Certification with over 28 years of relevant experience. He is a member of the CCBA Debtor-Creditor Law Committee, and regularly advises and represents debtors, creditors and bankruptcy trustee in bankruptcy, foreclosure and related matters.