Ocwen is familiar to bankruptcy attorneys because it is the name of a dark force in real estate predation.  (At the end of this post I’ll tell you an Ocwen war story from my own practice that gives a little taste of what my clients have faced with them.)  It is also a name that has been in several recent articles in the Los Angeles Times.  The articles chronicle the fall of Ocwen in California, leading up to California’s move to deport Ocwen from the Golden State.  It couldn’t happen to a more deserving entity.

 

I.  Insurance Fraud

 

I’ll start with the September 17, 2014, L.A. Times article, which is really beginning near the end of California’s Ocwen story, because one can only take just so much wallowing in a cesspool of moral and financial degradation.  In that article, E. Scott Reckard reported:

Tyesha Hansborough and her husband, Christley Paton, had paid the property insurance on their Inglewood home along with their mortgage, putting the money in escrow like most homeowners.  Trouble is, the couple said, their mortgage servicer — Ocwen Financial Corp. — didn’t pass that money on to the insurance company for this year’s premiums.  They battled unsuccessfully for months to reinstate the lapsed policy without additional costs, the couple said.  Ocwen instead imposed so-called force-placed insurance — expensive coverage that protects the lender’s interest but doesn’t shield the homeowners from loss.

Isn’t that a cute trick?  Collect insurance premiums from the homeowner and then charge them again, for Rolls-Royce priced insurance.  That’s how to turn a real profit.  Don’t waste time with honest business practices:  That’s for suckers.

Picking up on the same insurance fraud theme, in the September 21, 2014, L.A. Times Lew Sichelman reported: Continue Reading California Seeks To Divorce Itself From Ocwen

A fellow bankruptcy attorney recently posed an interesting question regarding a threatened foreclosure sale before the automatic stay is lifted in a Chapter 13 bankruptcy.  Here is the exchange I had with her:

Question:

            Background Facts:

I just got an email from a Chapter 13 client who has a confirmation hearing on 8/21.  She told me that auction.com just came by her house and posted a sign that her house is up for auction on 8/14.  There has been no relief from the automatic stay issued in this case, nor has a motion for relief from the automatic stay been filed.  When we filed the case in March, we stopped a foreclosure action and the client was going to try to save her home so we put the arrears and some IRS tax debt in the plan.  Her original confirmation hearing was on 6/21 but the Chapter 13 Trustee’s office continued it to 8/21.  In the interim she lost one of her jobs and decided that she would just surrender the home and pay the priority tax debt in the plan.  We amended the plan indicating that she would be surrendering the home, but no arrangements have been made yet on the terms of the surrender.

            The Question:

Doesn’t the bank still need relief from the automatic stay to auction the house?

My Answer:

I.          The Terms Of The Confirmed Plan Will Bind The Debtor

The Bankruptcy Code provides:  “[T]he court shall confirm a plan if — . . .  [for an] allowed secured claim provided for by the plan — . . . the debtor surrenders the property securing such claim to such holder . . .”  11 U.S.C. § 1325(a)(5)(c).  Thus, your client is entitled to propose a plan in which she surrenders her home to the creditor holding the first mortgage.  Once the Court confirms the plan, its provisions will “bind the debtor . . .”  11 U.S.C. § 1327(a), meaning that she will have to surrender the home. Continue Reading The Automatic Stay In Chapter 13, And Foreclosure Sales

I recently had an interesting email exchange with a couple of fellow bankruptcy attorneys on the subject of foreclosure.  The specific question we discussed was whether a second mortgage holder’s claim is extinguished after the holder of the first mortgage conducts a foreclosure sale.

The question is complicated by the fact that there are three relevant statutes at work, and they don’t have the same foci.

I.          The “One-Action” Rule

The first statute is Cal. Civ. Proc. Code § 726, which states in relevant part:

There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property or an estate for years therein, which action shall be in accordance with the provisions of this chapter.

This means that if a creditor holds a mortgage on a piece of property, it has one bite at the apple:  it can either foreclose on the property, or sue the borrower to collect on the debt, but not both.  Thus, if the lender conducts a foreclosure sale and comes up short, it cannot sue the borrower to collect the post-resale deficiency.  The shortfall has to be cancelled, which is why the (former) homeowner can face a nasty tax bill after losing the home. Continue Reading The Treatment Of A Second Mortgage After A Foreclosure Sale

Although I posted an article on this topic of tax debts after foreclosure on July 12, 2011, this question still comes up fairly frequently.  Therefore, another blog post on it is in order.  However, this one will not be a carbon copy of the July 12 post.

I.          The Five Exceptions To Cancellation Of Debt Income Tax

When a creditor forgives a debt you owe, the forgiven debt is usually credited to you as income for tax purposes.  The typical scenario these days involves the loss of a home in a foreclosure or a short sale.

Due to a provision in California real estate law, if the lender comes up short after the sale, it cannot come after you for the deficiency.  Instead, it will report the loss to the IRS and the Franchise Tax Board (“FTB”).  When it does, it will send you a 1099-C Form, listing the amount of debt it had to cancel.  This is your cancellation of debt income, and it’s taxable unless it falls within five exceptions listed in the Internal Revenue Code, and incorporated into the California Revenue & Taxation Code.

Those five exceptions are:

• the discharge – i.e., the debt forgiveness – occurred in a bankruptcy,

•the discharge occurred when you were insolvent,

•the indebtedness discharged was qualified farm indebtedness,

•in the case of a taxpayer other than a C corporation, the indebtedness discharged was qualified real property business indebtedness, or

•the indebtedness discharged was qualified principal residence indebtedness which was discharged before January 1, 2013.

For the first exception to apply, you have to have filed the bankruptcy before the debt was forgiven.  That way the debt is discharged in the bankruptcy.  If the debt is forgiven before you file the bankruptcy, then at the point of forgiveness the identity of the creditor changes from the bank to the taxing authority, and the debt you have is a tax debt instead of a mortgage debt.  Tax debts are usually not dischargeable in bankruptcy, so you could be out of luck.  (I’ll discuss the dischargeability of income tax debt in bankruptcy in my next post.)

For the second exception to apply you have to still be insolvent immediately after the debt was forgiven.  To illustrate what could go wrong, let’s use an example.  Suppose just before a foreclosure sale on your home your total debt was $525,000 – of which $500,000 was your mortgage debt.  And suppose your assets including the house were worth $450,000, with the house being worth $300,000.  At that point you would certainly be insolvent because the value of your debts ($525,000) exceeds your liabilities ($450,000).  However, insolvency for the second exception is measured after the sale, not before.  Thus, if the house sold for its market value of $300,000, and the bank forgave the post-sale shortfall, then after the sale your assets would be in value $150,000 (= $450,000 – $300,000), and your liabilities would be $25,000 (= $525,000 – $500,000).  This would mean that the value of your assets ($150,000) would be greater than your liabilities ($25,000), so you would no longer be insolvent – and you would be ineligible for the insolvency exception.  Ouch.

The third and fourth exceptions generally do not arise in the typical consumer bankruptcy case.  Therefore, if you think you might be eligible for either of them, consult a competent tax professional.

The final exception sunsets on January 1, 2013, and was enacted in response to the current housing mess.  If you lost your principal residence – this one does not apply to a rental property – and the debt that was forgiven was the original purchase money debt, then the amount forgiven after the sale does not get added to your gross taxable income.  Unfortunately, if you refinanced your home, and later lose the property, the debt forgiven would not qualify for this exception – unless you could prove to the taxing authority’s satisfaction that every penny of the refi went into home improvement.

If the forgiven debt does not fall within the ambit of any of these five exceptions, prepare for a tax hit.

II.        Filing The Tax Return

Suppose you were smart and filed for bankruptcy protection before the debt was forgiven.  Then the debt was discharged in a bankruptcy, so you don’t get the tax hit.  But the taxing authority won’t know that the debt was discharged in bankruptcy.  Contrary to what you see in the highly entertaining Bourne movies, the federal and California governments, and in particular, the IRS and the FTB, are not omniscient.

Therefore, when the taxing authority receives the 1099-C from the (former) creditor, it will assume that the cancelled debt should be credited to you as income.  To obviate this problem you should include the one-page Form 982 with your tax return – both state and federal – and check box 1 a because the debt was discharged in a title 11 case; title 11 of the U.S. Code being the U.S. Bankruptcy Code.

You may wish to consult a tax professional to help you complete your tax returns.

If you’re close to losing a home in foreclosure, or expect to have a creditor forgive a debt you owe, hire an expert los angeles bankruptcy attorney to help you before it’s too late.  Good luck.

Bankruptcy filings should surge in 2012 because the foreclosure pace is picking up speed, and because the world and U.S. economies are not headed for improvement in the near future.

I.          Foreclosures In 2012

I haven’t written about foreclosure in a while, but an article in the Thursday Los Angeles Times has given me the impetus to do so.

In the January 12, 2012 Business Section, E. Scott Reckard reported:

California and other states are likely to see an enormous wave of long-delayed foreclosure action in the coming year as banks deal more aggressively with 3.5 million seriously delinquent mortgages.  And experts said that dealing with the foreclosure process, from issuing notices of default to selling repossessed homes, is likely to push housing prices lower this year before the real estate market has a chance to recover.

Wow!  Three and a half million seriously delinquent mortgages.  That’s a lot of toxic real estate.  If you’re one of those 3.5 million people with a seriously delinquent mortgage, isn’t it time you considered bankruptcy?

II.        The World Economy

Is that the only bad financial news?  You know better than that.  Here’s what Sue Chang of the Wall Street Journal’s Market Watch reported on Friday, January 13, 2012:

Standard & Poor’s late Friday stripped France and Austria of their triple-A ratings and also downgraded Spain, Italy, and Portugal.  France and Austria are now both rated AA+ while Spain is at A and Italy is rated BBB+.  Meanwhile, Portugal’s rating was slashed to a junk grade of BB.  The move had been anticipated after the ratings agency placed 15 euro-zone countries on CreditWatch negative in early December. Continue Reading The 2012 Foreclosures, The World And U.S. Economies, And Bankruptcy

When the foreclosure sale looms large, filing for bankruptcy protection prior to the sale date is probably the only smart move. It avoids the unpleasant post-foreclosure sale tax hit, and frees you from owing the bank anything.

Those of you who have followed these posts for a while know that I have predicted a new wave of residential and commercial foreclosures. I stand by that prediction, the residential portion of which has just been bolstered by a recent article by Don Lee in the Los Angeles Times: Continue Reading Foreclosure And Bankruptcy: An Update

A recent corrupting trend in Chapter 13 bankruptcy is creating serious challenges for honest Chapter 13 debtors, their attorneys, mortgage companies, and Bankruptcy Courts.  The problem is a new foreclosure scam called property dumping, and it illustrates the ingeniously evil thinking of some real estate crooks.

Property dumping has cropped up in response to the desperation of homeowners facing foreclosure sales.  It involves a fraud on the Court, pure and simple.  Here’s the typical scenario:

A homeowner facing foreclosure is told by the crook that he can postpone the foreclosure sale for many months for a small fee – say $1,500.  As part of the process the crook has the homeowner quitclaim the house to himself (i.e., to the homeowner, not to the crook – we’re using the reflexive pronoun correctly here; deeding the home to the crook is a different scam that’s been around for years) and an unnamed person – the name line is left blank, and the deed is not dated.  The crook then finds a recently filed Chapter 13 bankruptcy case, backdates the quitclaim deed to prior to the date the bankruptcy was filed, lists the Chapter 13 debtor in the previously blank name line, and then photoshops the County recording stamp and notary stamp from a previously recorded valid deed onto the bogus one.  The crook then sends the fraudulent deed to the mortgage company and claims that since the Chapter 13 debtor is on title to the property, the automatic stay of 11 U.S.C. § 362(a) is in force, so the foreclosure sale is halted.

The mortgage company then files: (a) a motion for relief from the automatic stay, (b) a proof of claim in the Chapter 13 bankruptcy case for the large outstanding mortgage arrearage, and (c) an objection to plan confirmation on the basis that the Chapter 13 plan fails to provide for the mortgage arrearage.  The results include a protracted confirmation process in the Chapter 13 case, lots of unnecessary costs incurred by both the victimized Chapter 13 debtor and the mortgage company, and a clogging of the Bankruptcy Court.  Pretty clever, n’est pas?  Actually, it’s downright illegal, and should lead to some free room and board for the malefactors.

Although this is a growing problem, I have not yet heard of criminal charges being filed against anyone by the U.S. Attorney’s Office.  However, I recently chatted with one of the bankruptcy judges in the Central District of California, and he indicated that the problem was serious enough to warrant a major push by the U.S. Attorney’s Office.  The nature of this scam makes it fall within the Racketeer Influenced And Corrupt Organizations (RICO) statute of title 18 of the U.S. CodeSee, in particular, 18 U.S.C. § 1961.  The penalties for RICO violations are outlined in 18 U.S.C. § 1963, part of which is reproduced below:

Whoever violates any provision of section 1962 of this chapter shall be fined under this title or imprisoned not more than 20 years (or for life if the violation is based on a racketeering activity for which the maximum penalty includes life imprisonment), or both, and shall forfeit to the United States, irrespective of any provision of State law—

(1) any interest the person has acquired or maintained in violation of section 1962;

(2) any—

(A) interest in;

(B) security of;

(C) claim against; or

(D) property or contractual right of any kind affording a source of influence over;

any enterprise which the person has established, operated, controlled, conducted, or participated in the conduct of, in violation of section 1962; and

(3) any property constituting, or derived from, any proceeds which the person obtained, directly or indirectly, from racketeering activity or unlawful debt collection in violation of section 1962.

I predict that sometime in the near future we’ll read of arrests of these crooks, and later that they have been given long stays in government housing.  Stay tuned.

Over the last few weeks Alejandro Lazo of the Los Angeles Times has written about new mortgage problems looming on the horizon.  On September 14, 2011 he discussed the toxic combination of relatively high interest rates and heavily underwater property values as presaging the next wave of residential foreclosures.  He observed:

A total of 10.9 million homes with a mortgage were in a negative equity position at the end of the second quarter, constituting 22.5% of all residential properties with a mortgage, according to Santa Ana research firm CoreLogic.  That was only a slight decline from 22.7% during the first three months of the year. And of those “underwater” homeowners in the second quarter, 3 out of 4 were paying interest that was above the market rate, the data show. . . . Economists consider high mortgage payments on homes that are underwater, or worth less than the debt owed on them, to be more likely to lead to foreclosure. Homeowners in this situation can feel hopelessly trapped and more willing to give up paying.

He made a great point:  the next wave of residential foreclosures is on its way. 

By the way, there is a wave of commercial real estate foreclosures headed our way.  Those who live in the Los Angeles area must have an inkling of this as they drive around the southland and see all of the “for lease” and “available” signs everywhere.  However, that was not Mr. Lazo’s focus.

Yesterday Mr. Lazo looked at the federal government’s recent move to gradually extricate itself from the mortgage business:

Uncle Sam is about to take a first tentative step out of the mortgage business by lowering the size of home loans that the federal government will guarantee, and it’s already hitting California neighborhoods with higher costs and bigger down payments.

Where does that leave us?  Those of you that are familiar with my previous discussions on mortgage debt and the federal government’s role in the current mess will not be surprised to learn that on one level I think it is a good thing for Uncle Sam to reduce his presence in the mortgage and real estate markets.  If he does, it will help the housing market to get to its natural level more quickly than it would with his meddling.

While Mr. Lazo is quite correct that a reduction of government interference will lead to lenders requiring larger down payments, this will reduce the likelihood that people lacking the income to make the monthly mortgage payments will get into houses they can ill-afford.  Putting someone in a house with a loan that requires 75% of that person’s monthly income to cover the mortgage payments is part of the kind of folly that led to the current financial mess. 

While one version of “compassion” says that the government should step in and guarantee home loans for people who can’t possibly afford the monthly payments – it was this sort of compassion that led to the option ARM meltdown – true compassion does not put people into this sort of untenable financial situation. 

My sense is that housing is still overpriced because sales continue to drop.  The ridiculously high home prices a few years ago were created by government interference into the natural market mechanisms, and it will take some time for the prices to drop to their natural levels.  Once the market returns to the natural sensible setting where only those who can afford to make the monthly payments will get a mortgage, house prices will have returned to their natural levels.

By the way, it doesn’t take great perspicuity to see that government interference in the market created unnatural incentives that led people to do things they otherwise wouldn’t have done.  After all, humans respond to both incentives and disincentives.  Unfortunately, while the underlying policies may have been put forward with the best of intentions, they led to unintended but very destructive consequences. 

The truth is that any governmental policy should be based on the way people really are, not on the way some theoretical model says people ought to be.  As the nightmarish socialistic/communistic experiments of the twentieth century Soviet Union, 1940s National Socialist Germany, 1970s Cambodia and Ethiopia, etc.,  . . . amply demonstrate, humanity cannot be reengineered to fit theoretical models.

Unfortunately, the United States has had its share of failed social experimentation (though thankfully, without the breathtaking mass murder of the aforementioned hellholes).  As I detailed in previous posts, the Community Reinvestment Act was the failed social tinkering that led to the housing debacle.  Perhaps a much needed extrication of government from the housing and mortgage markets will slowly undo some of the damage.

That said, while I am very optimistic about the spirit of the American people, I am less so about the government’s willingness to back off from the real estate and mortgage markets.  Too many of the people involved have the “hall monitor” mindset that makes it impossible for them to go gentle into that good night. 

This came home to me years ago while I was in law school.  During a friendly conversation, one of my fellow students decried the supposed problem of “urban sprawl”, and told me that he thought a legitimate role for government was to “force people to live in downtown metropolitan areas and use public transportation, rather than live in suburbs and drive their cars.”  He never explained to me why he thought that government officials were in a better position to decide where and how people were supposed to live than the people themselves.

In any event, I will not be surprised if Uncle Sam changes his mind and gets back into the mortgage business.  Stay tuned.

It is not news to say that today’s real estate market is terrible.  Many “homeowners” are quite literally hundreds of thousands of dollars underwater.  I put homeowners in quotation marks because someone who is underwater does not really own a single molecule of the house.

This leads many to surrender their houses as part of the bankruptcy process.  Surrender of the house can be very sensible if the debtor can’t make the payments, and has negative equity.  When the Bankruptcy Court grants the debtor a discharge, the personal liability on the mortgage is discharged.  Moreover, since the debt is discharged in the bankruptcy, there is no cancellation of debt income, so there is no adverse tax consequence to the surrender.  In addition, any prepetition homeowners association (HOA) dues are discharged because they were incurred prior to filing the bankruptcy papers.

However, postpetition HOA dues are not discharged in the bankruptcy because they are incurred after the filing of the bankruptcy papers.  See 11 U.S.C. § 523(a)(16).  In the current real estate market this unfortunate fact can create a real problem because if the debtor surrenders the property the lender is not required to take possession of it, or record a transfer of title.  In the vernacular:  you take force someone to accept a gift. Continue Reading Homeowners Association Dues And Bankruptcy

I.          The Basic Idea:  Cancellation Of Debt Income

Let’s first understand the basic idea with a simple non-real estate example.  Suppose you owed me $100,000.  I’m such a nice guy that I forgive the debt.  It turns out that this becomes a mixed blessing because now the IRS and the Franchise Tax Board (FTB) both will demand that you pay income tax on the $100,000.  Why?  Their reasoning (this is well-established law with a pedigree going back many decades):  My forgiving you the $100,000 debt was economically equivalent to your earning $100,000 and paying me off.  Or put another way, when I forgave the debt you got a $100,000 benefit.  This benefit is then credited to you as income.  It is sometimes referred to as cancellation of debt income, or imputed income from discharge of indebtedness, and with a few exceptions (that I’ll discuss below) it is taxable income.

II.        Post-Short Sale/Post-Foreclosure Sale Cancellation Of Debt Income

Let’s apply the basic idea we just developed to the loss of your home in a short sale or a foreclosure sale.  For simplicity let’s assume you have just one mortgage.  Suppose, for example, that you owe $450,000 and the house sells for $350,000 – this kind of short fall is not all that unusual these days.  Then the bank came up short by $100,000 after the sale. 

            A.        The Short Sale

When you sell your home in a short sale, the bank agrees to accept less than you owe, with the understanding that the bank will not try to sue you to collect the post-sale deficiency.  However, since the bank will want to use its $100,000 loss to offset its other income, and thus reduce its tax liability, it will not agree not to report the loss to the taxing authorities.  When the IRS and the FTB get wind of the loss, they will come after you for the tax on the cancellation of debt income.

            B.        The Foreclosure Sale

In California we have an anti-deficiency statute found in Cal. Civ. Proc. Code § 580(b) (http://).  The gist of it is that if you lose your home in a foreclosure sale, the foreclosing entity that lent you the money to buy the house in the first place – almost always the holder of the first mortgage – cannot come after you to collect the post-sale deficiency.  What will it do?  Based on the previous discussion it should be obvious that bank will report the loss to the taxing authorities to get the write-off.  And now you owe tax on the cancellation of debt income.

III.       Some Carve-outs In The Tax Codes

The Internal Revenue Code has five important carve-outs that waive cancellation-of-debt income tax.  They are are found in 26 U.S.C. § 108(a).  These carve-outs are incorporated into California tax law by Cal. Rev. & Tax Code § 24307(a).

The five carve-outs are:

  • the discharge occurs in a bankruptcy,
  • the discharge occurs when you were insolvent,
  • the indebtedness discharged is qualified farm indebtedness,
  • in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or
  • the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013.

Based on the first carve-out, any debts that are discharged in bankruptcy do not give rise to cancellation of debt income.  You can discharge any amount of debt in bankruptcy and not owe a dime in taxes on that cancellation of debt income.  (Here’s my little chest-beating for this blog post:  I once got rid of $2,000,000 for a single debtor in a Chapter 7 bankruptcy, and he owed zero in cancellation of debt income tax.)

Therefore, if you think you’re going to lose your house anyway, why not file for bankruptcy protection and surrender the property as part of the bankruptcy?  You’ll end up not owing anything on the house, and you won’t owe cancellation of debt income taxes.

Important Caveat:  The debt must be discharged in the bankruptcy.  If you already lost your house in a short sale, or a foreclosure sale, before you filed the bankruptcy papers, then this carve-out won’t help you.

The second carve-out applies if you are still insolvent immediately after the debt was forgiven.  If you’ve already lost your home and didn’t file for bankruptcy before the loss, you should talk to a competent tax professional to determine whether this carve-out applies to you.

If you lost your home in a short sale, or a foreclosure sale, then the third and fourth carve-outs don’t apply to you.

The last carve-out could still give you relief.  It is a temporary one that expires on January 1, 2013, and only applies to “qualified principal residence indebtedness.”  The meaning of that phrase is a bit complicated, but the gist is that the forgiven debt must have been purchase-money debt – i.e., you incurred the forgiven debt to buy the house in the first place, or if you refinanced, every penny of the refi went into home improvement.  Thus, if you used the house as an ATM machine to get money to do something like take a vacation – a lot of people did this when real estate prices were high – then this carve-out doesn’t apply to you.

Finally, you may have had a capital loss associated with the sale, that could help to offset the cancellation of debt income.  Consult a tax professional to see if this applies to you.

In sum, the only sure-fire way to avoid cancellation of debt income tax is to have the debt in question cancelled – i.e., discharged – in bankruptcy.