Crazy Real Estate and Mortgage Markets Create Dilemmas for Buyers. Cost Basis, Assessed Value, Unreported Income, and Situational Ethics all Come into Play.

If a tree (earnings) falls in the middle of the forest and the IRS isn’t there to hear it, is it still income?

February 19, 2008 – Palm Coast, FL – The turbulent real estate market has opened a Pandora’s Box of issues for sellers, buyers, lenders, public officials, and regulatory agencies. Many of these issues are not new but because they were not significant or because they occurred infrequently, they existed below the radar and could easily be ignored or tolerated. No longer infrequent, they have been joined by a new class of dilemmas. Being neither an accountant nor an attorney, I am not qualified to advise you on these matters. My role is simply to expose issues that may carry significant consequences.

Buyer incentives – You purchase a piece of property. The seller includes some valuable incentives, perhaps worth several thousand dollars as an inducement to buy (e.g. club memberships, club dues, waiver of association fees, or the seller pays mortgage interest for a period of time). While the incentives are enumerated in the sales contract, they are not indicated on the HUD Statement or the deed which is the document on which the appraiser’s office relies.

Here are some interesting questions that arise from such a transaction:

• What is the true value of the incentive package?
• Should you go to the property appraiser’s office with your sales contract in an effort to lower the property’s assessed valuation by the value of the incentives?
• Did the seller issue a 1099 tax form to report the value of the incentives as income?
• What cost basis will you use? Will you use the deed value or the deed value net of incentives?
• Will you report the incentives as other income when you file your tax return?

Lost loan documentation – Most recent mortgages were packaged and sold to investors, often changing hands several times. A recent court ruling tossed out foreclosure proceedings when the lender could not provide proof they owned the note and mortgage. So what happens if the lender cannot foreclose?

• If they can’t foreclose, do you still have to pay?
• If you don’t pay, but the lender doesn’t forgive the loan, is the unpaid balance income?
• What happens to the lien on the property?
• Could you sell the house with the lien still attached with the new buyer knowing they didn’t have to pay either?

Private Mortgage Insurance (PMI) – When a buyer’s down payment is less than 20%, lenders usually require PMI, which pays the lender in the event the buyer defaults on the mortgage. The buyer is not a party to the PMI contract. Nor are the terms of the contract disclosed to the buyer. But the buyer is responsible for the PMI premiums. They are typically added to the monthly mortgage payment. In the event of foreclosure, the bank collects the face amount of the PMI policy. The amount collected may exceed the loss experienced by the bank net of foreclosure and selling costs.

Since the property owner paid the premium on the PMI policy, shouldn’t they receive any insurance settlement in excess of the banks documented loss?

• If the property was not owner occupied, should the bank be allowed to obtain a deficiency judgment against the owner, even though the lender’s loss was mitigated by the PMI settlement?
• If the unpaid loan balance is forgiven, should the forgiven amount be reported as income even though the bank’s loss was covered by the PMI settlement?
• Can the PMI insurer sue the property owner for the amount of their settlement to the lender?