One of the common questions we get in our law practice is “If I agree to give up my property in foreclosure to the bank, do I still owe money on the mortgage?”
This, of course, is an excellent question and should top of mind for anyone considering settling a mortgage foreclosure with the lender.
Let’s start with an example: a homeowner named Rick is getting foreclosed on by Bank ABC. Rick’s property is currently only worth $300k but with default interest and all of the other fees, he owes $500,000 on his mortgage. This means he is “underwater,” meaning he owes more on the note and mortgage than the property is worth.
So what then happens if you agree for the bank to get a foreclosure judgment and sell the property at the auction block, what happens if the property sells for less than you owe on the note and mortgage?
The answer will depend on the settlement agreement you negotiated. Here’s why:
When you are negotiating a settlement like that, called a cash for keys settlement, you can ask for a waiver of deficiency or you can go without the waiver of deficiency.
If you do get a waiver of deficiency built into the settlement agreement, the bank has no legal right to sue you for the difference.
That sounds good, doesn’t it? There’s a catch. The catch is that the IRS may consider the amount the bank has forgiven to be taxable income to you, which can trigger tax liability for you.
Disclaimer: I am not an accountant or a tax attorney so we will typically refer the client to an accountant to determine whether the client will actually owe the IRS. I believe this hinges on how much debt the client has versus the value of their assets.
If you do not get a deficiency waiver built into the settlement agreement, then the bank legally could sue you for the difference, but it is highly unlikely that they do. They rarely do these days.
In addition, the bank only has a short window of one year in which to bring the deficiency action due to the statute of limitations. See Fla. Stat. 95.11(5)(h).
In most cases, you could elect not to go with a waiver of deficiency, thereby guaranteeing no tax liability, and the odds are in your favor that the bank will most likely not sue you for the difference. Just remember that the bank would still have one year to do so, so that’s still a gamble that you would be taking.
Finally, please keep in mind that whether the property is your principal residence does not make a difference anymore on the deficiency issue. It used to be federal law that the IRS could not count the mortgage debt forgiveness as taxable income if the property was your principal residence, but the Congress let that protection lapse.
Ryan C. Torrens, Esq.
Consumer litigation attorney