March update on real estate and bankruptcy

The New York Times had two articles on Friday, February 29, 2008 that we believe will be of interest to the readers of our blog. The first article indicated that based on comments by President Bush, lobbying by the Mortgage Bankers Association and the opposition of Senate Republicans, the bill proposed by Congressional Democrats to allow bankruptcy judges to modify the terms of first mortgages (i.e. to increase the length of the mortgage and/or to decrease the interest rate on the mortgage) is now dead. However, the Democrats in the House and Senate have indicated that they may renew their efforts to pass this type of legislation in the future.

The second article in the New York Times was titled "Facing Default, Some Abandon Homes to Banks." A copy of that article can be found on our personal bankruptcy website and on our blog. The article deals with an issue of great interest today, which is the abandonment of one's house. Many clients have called us regarding abandoning their house or giving the house back to the bank in lieu of foreclosure or letting the bank foreclose on the house. This scenario generally occurs when the amount of mortgages that encumber the house exceed the value of the house. There are three legal issues regarding this strategy that all clients should be aware of.

The first issue is federal income tax (i.e. relief of indebtedness income). If an individual abandons a house and the mortgage is greater than the fair market value of the property, then theoretically the difference between the mortgage and the value of the collateral would be deemed relief of indebtedness income and would be reported by the banks on a 1099-R to the Internal Revenue Service. However, based on legislation that was passed by the House and Senate and signed into law by President Bush, there is no relief of indebtedness income on the abandonment of real estate during the years of 2007-2009. You can read more about relief of indebtedness income and other recent changes in bankruptcy law in our January 16, 2008 post.

Another issue concerning the abandonment of real estate is New York State Debtor and Creditor Law. If an individual abandons or walks away from a mortgage, the bank (mortgagee) can foreclose on the property and under the RPAPL, seek a deficiency judgment against the borrower. If the bank seeks the deficiency judgment and they are successful in obtaining a judgment, under New York law, the judgment will be good for 20 years. When a creditor in New York obtains a judgment, typically there are three remedies used to collect on that judgment. First, they will docket the judgment in a county where the debtor owns real estate; Second, they will attempt wage garnishment-they will use a sheriff or marshal to garnish 10 percent of a debtor's wages or earnings; and Third, they will use the judgment to lien and levy on banking, savings or brokerage accounts which a debtor may have. If a debtor is faced with this situation, they must make themselves "judgment proof," which means they cannot own or take title to any real or personal property. However, a Chapter 7 bankruptcy filing would discharge the judgment under bankruptcy law.

The third issue concerning the abandonment of real estate is one's credit report. Under federal law, an individual who abandons their house and is subject to foreclosure will have this information reported on their credit report for up to 10 years. Additionally, if an individual abandons a house and the creditor obtains a judgment, that individual will not be able to obtain credit until the judgment lapses pursuant to New York State law (20 years), is satisfied or discharged in bankruptcy. Practically, that means that an individual with an open judgment or a tax lien would not be able to buy real estate, or purchase or lease a car.

However, a Chapter 7 personal bankruptcy filing will have the following positive effects for an individual:

1. It will discharge relief of indebtedness income, which would be helpful after 2009.
2. It will discharge judgments; and
3. It will actually make it easier for an individual to obtain credit, because the judgment and other liabilities are "discharged" in bankruptcy and banks know that an individual can only file for Chapter 7 bankruptcy every eight years.

Finally, with respect to credit report issues, a personal bankruptcy is generally no worse on a person's credit report than a judgment or foreclosure. Anyone who has issues concerning the abandonment of real estate should contact Shenwick & Associates for further information.