Is Help for Troubled Homeowners Too Good to Be True?

If you are one of the San Fernando Valley’s many financially strapped homeowners facing a possible foreclosure or trying to get your lender to accept a sale of your home for less than the current loan balance, several new companies claim that they can minimize your woes.

Homes America in Los Angeles contends that it “will help solve all your problems today.” Another firm, Boston Harbor Corp. in San Diego, says it “has found a way to solve your problems.”

If you think that this sounds too good to be true, you may be right. The methods being employed by these companies to help troubled homeowners are controversial, and the Internal Revenue Service has still not reached an opinion on the tax implications of the services these new companies are selling.

Usually when a lender forecloses on a homeowner, that foreclosure remains a blemish on the debtor’s credit history for up to seven years. But a growing number of borrowers with no equity left in their homes are trying to avoid foreclosure by selling their homes and getting their lender to agree to a so-called short sale, or short pay-off, whereby the lender basically accepts the proceeds of the sale and forgives the borrower any difference between the sales price and the loan balance. There are two hitches, however. First, the borrower has to persuade a lender to go along with the short sale. Second, any debt that is forgiven by the lender is considered taxable income by the IRS and the California Franchise Tax Board.

Boston Harbor, Homes America and other similar companies claim that they can help homeowners by taking over their property. These companies claim that by signing over to them the deed to your house, you can save your credit rating and maybe save some taxes. How? They take over your house and then, as the new owners, try to negotiate with your lender. You, however, remain responsible for the loan. If the lender agrees to a short sale, you won’t be liable for any tax on debt forgiveness because you didn’t own the home when the debt was “forgiven”--or so the argument goes. If there is a foreclosure, say the companies, it shouldn’t appear on your credit history because you didn’t own the home when it was foreclosed.

This practice is so new that even the IRS doesn’t know what to make of it. “We are trying to come up with a position. There isn’t a definite answer from (Washington) yet,” said Robert Giannangeli, public affairs officer for the IRS in Los Angeles. His advice to homeowners in the interim is to beware. “You could cause yourself no end to pain and suffering,” he said.

There are other possible problems. Here’s one example:

Jane is a homeowner who can no longer afford the residence she bought three years ago for $190,000 with a $160,000 mortgage. Today, the loan balance is down to $150,000, but the home is only worth $130,000.

If Jane lets the lender foreclose, she now has a checkered credit rating. If Jane finds a buyer willing to pay $130,000 and she persuades the lender to accept that as payment in full, Jane will owe taxes on $20,000 in debt forgiveness.

Boston Harbor and Homes America say they can help negotiate a short sale and help Jane avoid the tax she would otherwise have to pay for the debt forgiveness. If the lender won’t agree to a short sale, the companies claim that they can help keep the foreclosure off Jane’s credit record.

The tax situation becomes more complicated if Jane was carrying forward a profit from a previously owned property. If she made a $100,000 profit on her previous residence, then her “tax base” on the current property is $90,000 instead of $190,000. In that case, a short sale for $130,000 would leave her facing a capital gain of $40,000, for which additional tax has to be paid. But it gets worse. If Jane had transferred her residence to Boston Harbor, for example, the value of the transfer would be assumed by the IRS to be $150,000. Her taxable capital gain then becomes $60,000 instead of merely $40,000.

“We don’t address the capital gains aspect of these transactions,” conceded Eric Fagen, a San Diego attorney and president of Boston Harbor, which he founded a year ago. “There are a couple of sections of our brochure that we are going to rewrite.”

His company has a 22-minute video explaining how homeowners can avoid the tax implications of a short sale. The video fails to mention anything about the potentially ruinous affect of having to pay more taxes on capital gains. Such capital gains can only be avoided when a homeowner has the wherewithal to roll over the gain into another home within two years. This, of course, is hard to do for a family already facing financial ruin.

In Boston Harbor’s current brochure, some caveats are listed, such as: “We cannot guarantee that there will be no effect on your credit. . . . You should not consider (this) as a complete solution to all credit problems.”

Still, Fagen says the tax-avoidance scheme is perfectly legal and effective. “I believe the IRS would have stopped this practice if they could have by now. But they haven’t,” he said.

Homeowners simply have to sign a grant deed that hands over the property to his company--along with a check to Boston Harbor for 1% of the original loan balance. And, while Boston Harbor won’t assume the loan, he said, it does take over the property subject to the lenders’ security on that property. Because Boston Harbor takes over these properties as an “investment,” any “losses” generated by a short sale offset what becomes Boston Harbor’s taxable debt relief.

All told, Fagen said, Boston Harbor has started work on 350 transactions, including some properties in the San Fernando Valley. Only 35 have been successfully concluded so far, he said.

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Homes America, which has been in business for only about a month, is now working on two different residential transactions. “We’re very new at this,” admitted Ken Marker, a licensed real estate broker in Studio City and acquisition manager for Homes America. He also conceded that “there is no definite law on this.”

Like Boston Harbor, Homes America does not raise the issue for homeowners about the tax basis of their homes. This is essential, though. Capital gains are taxed by the feds at about 28%, while debt forgiveness is considered “ordinary income” and is taxed on a sliding scale of 15% to 39%, depending on your tax bracket. In fact, lenders must fill out an IRS form 1099 for any residential debt they forgive.

Homes America says it can’t insulate homeowners from potential deficiency judgments where homeowners are held responsible for any difference between their debt to a mortgage lender and the amount generated by a foreclosure sale. California law does protect borrowers from deficiency judgments if borrowers still have the original mortgage used to purchase their residence (as opposed to a refinanced mortgage).

California law also protects borrowers from deficiency judgments when a lender chooses to foreclose under a deed of trust and goes go through a trustee, as opposed to going to court. However, if your mortgage is not the original one you used to buy the home, a lender could go to court to foreclose and then chase after you for a deficiency judgment.

And if there is a second or third mortgage on the property, after the first lender forecloses, the other lenders can then pursue the former homeowner for a deficiency judgment to pay their loan balances.

I’m going to sound like a broken record. But, the bottom line to all this is: Consult a professional for help before you do anything.