Dubiln Packard

Todd Murphy

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Do I Have To Pay Income Tax After A Principal Reduction?

pay tax after a principal reductionPrincipal reduction is the Holy Grail of loan modifications but they are just so hard to get. If you are lucky enough to have principal reduction included as part of a loan modification, you may have to pay income tax on the amount of the principal reduction. Here’s Why….

 

Do You Have To Pay Income Tax After A Principal Reduction?

Just like a homeowner has to pay income tax on the amount of debt that was forgiven after a short sale, the same applies when the lender reduces the amount of the debt owed through a loan modification that includes a principal reduction.

IRS Publication 4681 provides all of the details.

The IRS treats cancelled or forgiven debt as income.  There are some exceptions.  For example: if you are insolvent or if you file for bankruptcy.  These are the two most common exceptions that apply to people in foreclosure. You may need the assistance of your tax preparer or accountant but take a look at IRS Publication 4681 which provides guidance on canceled debts.

Principal Reduction is Cancelled Debt.

In Publication 4681, the IRS clearly considers principal reduction as cancelled debt.  If you were given a loan that has a principal balance of say $400,000 and the lender agrees to modify your loan to a balance of $300,000, the lender cancelled $100,000 worth of debt and you may owe tax on that amount.

There may be an exception that applies to you.

Insolvency.  In Publication 4681, the IRS provides: Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the fair market value (FMV) of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include: The entire amount of recourse debts, the amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt, and, the amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven.

Bankruptcy. In Publication 4681, the IRS provides: Debt canceled in a title 11 bankruptcy case is not included in your income. A title 11 bank- ruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13), but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

Knowing where you stand with the IRS and whether or not you are going to have to pay income tax after a principal reduction is an important part of understanding your options when in foreclosure or trying to obtain a mortgage loan modification.

 

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Do I Have To Pay Tax After A Short Sale?

do i have to pay tax after a short saleGreat! You did a short sale and now your mortgage lender sent you a 1099C to pay income tax on the amount of the loan that was not paid at the sale.  What? Do you have to pay tax after a short sale?

Answer: maybe.

The IRS treats forgiven or cancelled debts as income.  Under IRS rules, the lender is required to notify the IRS and to send you a form 1099C which may obligate you the pay income tax on the forgiven amount when you prepare your taxes for the year of the short sale.  Let’s say you had a home mortgage loan where  you owed $350,000 and the lender approved a short sale for $250,000.  In approving the sale, the lender is also agreeing to take $250,000 (less expenses) as full payment on the loan.  That means $100,000 of the loan is forgiven.  The IRS looks at this forgiveness as income and wants you to pay tax on it.

There Are Exceptions That May Apply To You.

Waiver By Congress. Up until December 2014, Congress provided a waiver of the tax given the high number of home owners that were losing their homes after the financial crisis of 2008 but that law hasn’t been renewed at this point.  You may want to check to see if Congress has renewed the waiver but at this point, it does not appear likely.

IRS Rules.  You may need the help of your tax preparer or accountant but here’s what the IRS has to say about forgiven or cancelled debts.  In IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, the IRS explains the federal tax treatment of canceled debts in certain situations. In short, if you are Insolvent in the eyes of the IRS, you do not have to pay the tax.

Insolvency. If you are insolvent according to the IRS just before the debt was cancelled, this exception may apply to you.

In Publication 4681, the IRS provides: Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the fair market value (FMV) of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include: The entire amount of recourse debts, the amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt, and, the amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven.

A special note if you have retirement savings: 401(k)s and IRAs count toward your assets.  Please note that in the above guideline, the IRS does not exclude retirement savings from your assets.  This may prevent some people from qualifying for this exception. If you do have retirement savings, it is important to know that that retirement savings is exempt from assets in bankruptcy so in this case, bankruptcy may be a better option for you in that it saves you the tax and preserves your retirement savings.

Bankruptcy.  If you file for bankruptcy, whether chapter 7 or chapter 13, the bankruptcy exception may apply to you.

In Publication 4681, the IRS provides: Debt canceled in a title 11 bankruptcy case is not included in your income. A title 11 bank- ruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13), but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

There may be other exceptions that apply to you but these are the two that apply to most people.

This IRS rule also applies in the rare event the amount you owe is reduced as part of a loan modification or if the lender simply cancels your loan as sometimes happens with second mortgage loans when the lender realizes the value of the homes has dropped significantly.  You can read more about that here.

 

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Foreclosure Time Line In New Jersey

foreclosure time lineHow Long Does It Take in New Jersey to process a residential foreclosure action from start to finish?

The foreclosure time line in New Jersey has a number of variables depending on how the borrower reacts to each step along the way.  New Jersey’s Fair Foreclosure Act specifies, albeit indirectly, the minimum time frames necessary to process a residential foreclosure action in New Jersey.  At minimum, a un-contested residential foreclosure action can take as little as 169 days or, at maximum, as long as 200 days. This assumes the borrower is not working with an attorney and either did not file an Answer to the Complaint or filed what would be deemed a “non-contesting” Answer.

There are a number of basic steps to processing a foreclosure action in New Jersey.

Step One: Assuming default has occurred, the lender or its attorney must first notify the borrower that it is in default and that it has a right to cure that default 30 days prior to filing a Complaint in Court.

Step Two: File a Complaint with the Court, serve the Complaint on the borrower along with a Summons notifying the borrower that it has 35 days to file an Answer.

Step Three: assuming no Answer is not filed, the lender will ask the Court to enter a Default Judgment.  This usually takes about 30 days.

Step Four: Notice to the borrower that it intends to file for entry of final judgment providing the borrower with 14 days to notify the lender that it has a good faith ability to cure within 45 days.

Step Five: Lender files it proofs to enter Final Judgment.  This usually take 30 days.

Step Six: Final Judgment is entered and a Sheriff Sale is scheduled, borrower notified and the sale date is advertised in the official newspapers for four consecutive weeks.  28 days.

Step Seven: Sheriff Sale is completed.

Step Eight: Right to redeem expires and deed is transferred to buyer. 14 days

Total 181 days.  This is the minimum.

If your case proceeds as an un-contested action, 181 days is the shortest amount of time to fully process a residential foreclosure action in New Jersey but often it takes longer than this 181 days.

Bank Delays In Hopes of an Improved Real Estate Market.

Banks, particularly in a situation where the value of the property may not be as much as the amount of the loan, will delay a foreclosure in the hopes that the value of the property will increase over time.  In the meantime, they don’t aggressively process the case after the default judgment is obtained. There is a risk on the part of the lender, if either the Court or the borrower believes the lender is not in good faith processing the case, that the case might be dismissed for lack of prosecution.

Backlogs Can Add More Time.

Both lender attorneys and courts have been very backlogged with the large number of cases in process since the financial and housing crisis of 2008.  It has been typical for foreclosure cases to take as long as 1000 days to process through the courts simply because of the large number of cases that have to be processed.

Optional steps that can prolong the process.

There are a couple of instances in the above steps where the borrower can add some time.

Optional Step One: In Step Three above, file an Answer within the 35 days provide for in the Summons.  Although the Court may deem your Answer as “non-contesting” without a hearing, it may allow your case to proceed as “contested” if you file an Answer that raises certain facts about the loan. In such a situation a case management hearing will be held and the case will be schedule for a trial. It is very typical in this situation, though, that the lender will file a Motion For Summary Judgment challenging your Answer and have it deemed “non-contesting” and send it back to the foreclosure division for processing in the normal course.  This entire process could however add a minimum of 30 days to the process and often longer.

Optional Step Two: In Step Four above, the borrower could notify the lender that it has the ability to cure.  This could add 31 days to the process.

Optional Step Three: A borrower is entitled to two 2-week adjournment of the Sheriff sale for any or no reason.  This could add an additional 30 days to the process.

Optional Step Four: Even though the property may have been sold at a Sheriff sale and you the borrower and homeowner have been ordered to vacate the property.  If you don’t, the new owner will have to evict you as if you are a tenant at the property.  This could add at minimum 14 days to the process but often adds 30 to 90 days if the judge believes you really need time to find a new home to move to.

Litigation As An Option.

Everything discussed above assumes you have not hired an attorney and do not have a valid defense to the foreclosure action.  After consulting with an attorney, you may determine that it is to your benefit to contest the foreclosure action and fight back.  This changes everything above.  The time frames for a contest action are subject to much variation but more than likely would be much longer than the time frames set forth above.

Practically Speaking What Are the Time Frames I Can Expect?

Generally in New Jersey, we have been seeing cases take 18 to 36 months and sometime much longer than that if the lender simply does not process the case.  However, backlogs have been reduced quite a bit as of this date in mid-2015 and I just saw a case yesterday that went from Complaint to Sheriff sale in less than 12 months.

Every case is different.

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New Jersey Fair Foreclosure Act

Fair Foreclosure ActNew Jersey Fair Foreclosure Act was adopted to provide homeowners with the ability to cure a defaulted mortgage.

Good Public Policy To Cure Defaults.

The Legislature, when enacting the Fair Foreclosure Act, found that it was good for New Jersey for homeowners to be given every opportunity to pay their home mortgages, and thus keep their homes; and that lenders will be benefited when residential mortgage borrowers cure their defaults and return defaulted residential mortgage loans to performing status.

The Act Applies to Residential Mortgages Only.

The Fair Foreclosure Act applies only to residential mortgage loans in which the property is owner-occupied and does not contain more than four units.  “Owner” can extend to the owner’s immediate family.

Notice of Intention To Foreclosure.

The first protection arises in the form of a Notice of Intent To Foreclosure which must be a written notice sent to the borrower 30 days prior to filing a Complaint and initiating a foreclosure action notifying the borrower that it has the right to cure and of the amount of the default and how to cure the default.

Statute of Limitations.

This provision has had much attention lately in a Bankruptcy Court case where Judge Kaplan found in In Re Washington that the date from which the statute of limitations is calculated in addition to what is stated in the Act can also be the date the entire loan was accelerated.  This typically occurs in the Complaint when it is filed which means the Complaint would have had to have been dismissed for some reason and then re-filed within six years from the date of the first Complaint (the acceleration date).  This may be a rare occurrence but may apply if your case was dismissed for lack of prosecution or due to the large settlement in 2012.

Otherwise, the statute of limitations runs six years from the date for the making of the last payment or the maturity date of the note. 36 years from the date of recording the mortgage and 20 years from the date which the borrower defaulted.

Curing Default.

This is the cornerstone of the Act and provides that at any time during the foreclosure action, up until the date of entry if final judgment, the borrower can cure the default.

Notice Prior to Entry of Final Judgment.

An additional notice notifying the borrower that it has the right to cure must be sent to the borrower 14 days prior to asking the court to enter final judgment.  The notice notifies the borrower that it has the right to cure and that if the borrower believes he or she can cure with 45 days, to notify the lender within 10 days of the notice.  If such a notice is sent to the lender, the lender cannot ask for final judgment until 46 days has past.

Reinstatement of Mortgage Relationship.

In the event the default is cured, the lender is required to restore the borrower to the same position it held proper to the default.  In other words, the borrower can continue to pay the mortgage payments under the terms that were in place on the day of default.

If Your Hone Is Abandoned.

The Act does provide some relief to lenders if the home is abandoned.  The time frames and additional notices can be avoided if the lender can show to the Court that the home is abandoned.

Foreclosure Time Frame.

The Fair Foreclosure Act, with the addition of the additional notices and protections creates and extended time-frame for residential foreclosure actions which at minimum are 169 days and at maximum 200 days.  This of course assumes the borrower is not represented by counsel and is allowing the case to proceed uncontested (either did not file an answer or filed an non-contesting answer).  It also assumes the lender does not delay in processing the case and that the Court is not backlogged.  Click this link for more detailed information on time frames for a residential foreclosure action in New Jersey.

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Can I Defeat A Foreclosure Case Past The Statute of Limitations in New Jersey

statute of limitations for foreclosure complaint in new jerseyA Recent New Jersey Bankruptcy Court Case May Allow You To Defeat a Foreclosure Case If Your Complaint Was Filed More Than Six Years After Your Loan Balance Was Accelerated.

People Have Asked: “Can I Defeat A Foreclosure Case Past The Statute of Limitations?

THIS ARTICLE HAS NOW BEEN UPDATED WITH THE PASSING OF ASSEMBLY BILL 5001 as of February 2019.  See the updated article here: https://toddmurphylaw.com/new-jersey-revises-statute-of-limitations-on-foreclosures/

The New York Times posted an article in November of 2014 reporting on an interesting case in the New Jersey bankruptcy court where a judge – reluctantly – barred a foreclosure action because the complaint was filed beyond the statute of limitations under New Jersey’s Fair Foreclosure Act.  See NY Times Article Here.

Judge Kaplan in In Re Washington held that, “by application of N.J.S.A. § 2A:50-56.1(a) and (c), Specialized Loan Servicing was time-barred under New Jersey state law from enforcing either the note or the accelerated mortgage. As a result, Specialized Loan Servicing’s proof of claim was subject to disallowance under 11 U.S.C. § 502(b)(1) and deemed unenforceable against the debtor or the debtor’s property under applicable state law. As a result, the lender’s claim was unsecured, and the underlying lien was deemed void pursuant to 11 U.S.C. § 506(a)(1) and (d).”

What Does the New Jersey Fair Foreclosure Act Say About Statutes of Limitations?

The statute reads:

“1. An action to foreclose a residential mortgage shall not be commenced following the earliest of:

a. Six years from the date fixed for the making of the last payment or the maturity date set forth in the mortgage or the note, bond or other obligations secured by the mortgage, whether the date is itself set forth or may be calculated from information contained in the mortgage or note, bond, or other obligation, except that if the date fixed for the making of the last payment of the maturity date has been extended by a written instrument the action to foreclose shall not be commenced after six years from the extended date under the terms of the written instrument.  N.J.S.A. § 2A:50-56.1(a) (emphasis added).

What Happened in the Bankruptcy Court Case?

In a Bankruptcy Court Case title In Re Washington, The home owner purchase a three-family house in February 2007 with a 30-year adjustable rate Mortgage and Note. In July 2007 the borrower defaulted on the Note and the foreclosure action was filed by the Lender in December 2007. The foreclosure Complaint accelerated the due date for all amounts owed on the loan as a result of the payment default. In July 2013 the foreclosure action was dismissed for lack of prosecution due to the Lender’s failure to produce certain documents to the Court. The Lender did not appeal the decision or commence another foreclosure action against the homeowner. Then, on March 12, 2014 the borrower filed for Bankruptcy and commenced an Adversary Proceeding against the Lender to render the loan wholly unenforceable.

Citing the New Jersey Statute of Limitations, the borrower argued that the six-year statute of limitations applicable to loans as per the Fair Foreclosure Act (see N.J.S.A. § 2A:50-56.1) barred the Lender from commencing an action due to the borrower’s default on the note taking the position that the six-year statute of limitation period had expired due to the default and acceleration of the maturity date that occurred when the foreclosure complaint was filed in 2007. Judge Kaplan held that the six-year statute of limitation period applied to the foreclosure action and the Lender failed to commence a foreclosure action within the six year period following the accelerated maturity date that occurred back in June 2007. Therefore, the Lender’s lien was void and no longer enforceable against the Debtor. As a result, the Lender’s proof of claim in the Bankruptcy case was also barred due to the underlying lien being unenforceable as a result of the decision.

Acceleration Was The Key Here.

Because the loan was accelerated, the date of the last payment became the date of acceleration.  That date, in this case was December 2007.  Even though the lender filed a case within the time frame originally, the case was dismissed for lack of prosecution causing the lender to have to start from the beginning and in so doing, the Complaint was then filed outside the six year date.

How will this case hold up in New Jersey State Court?

Its worth a try.  This is still a recent case and the concept is only just beginning to be litigated in New Jersey State Court.  So, more will be know as those cases come down.  The NJ State Court is not required to follow the Bankuptcy Court case but can use it for guidance.  This particular set of facts doesn’t come up often since most lenders don’t wait so long to file a foreclosure action, but if your complaint has come more than 6 years after the lender declared you in default, then it is worth a try to raise this as a defense when you answer your complaint.

What You Should Do If You Are Served With a Foreclosure Complaint in New Jersey?

Don’t just ignore the Complaint.  You only have 35 days to file an answer.  As soon as you receive the Complaint, contact an experienced New Jersey foreclosure attorney who can review your situation and advise of the next steps.  If the date on the Complaint is six years after your loan balance was accelerated, look at this possibility carefully, review the latest State Court case law and determine whether or not this is a valid defense for you.

Can I Defeat A Foreclosure Case Past The Statute of Limitations in New Jersey?  Well, maybe!

 

*Update: The bankruptcy court case In Re Washington was overturned on appeal in August of 2015. The United States District Court for the district of New Jersey reversed its decision and now, the debtor does not get a free home, the mortgage must be paid by the mortgager.

If you want to learn more about saving your home from foreclosure, click on the button below to get your Free Consumer Guide To Foreclosure.