DEAR BERNICE: I have two investment properties in Hawaii. I paid $500,000 for them and now they’re worth $725,000 ($350,000 and $375,000). I owe about $379,000 on one and $399,000 on the other. The rental income has gone way down (from $6,500 per month to $3,500 per month.) The dues are very high. Do you suggest trying to do a short sale or should I go for a loan modification? –Rich S.
DEAR RICH: To obtain a short sale, you generally have to demonstrate hardship. Since these are both investment properties, it’s highly unlikely that you will get a loan modification from a lender. According to the U.S. Department of Housing and Urban Development, less than 3 percent of all applicants are approved for a loan modification.
The most important step that you can take right now is to talk to a certified public accountant (CPA) or a tax attorney. Since these are investment properties, different rules apply to their sale and how the losses are treated. There are a variety of issues that you need to address. First, how much is your cost basis in each property? Have you been claiming depreciation?
Have you taken any cash out of the properties by placing additional financing on the properties? Each of these issues must be taken into account so you can make the best decision possible about your choices. Please review the situation with a CPA or tax attorney before you do anything else.
Even if a short sale appears to be a viable solution, you will need a seasoned real estate professional to conduct the sale. Interview multiple agents and ask for references on the last five short sales that they did. If they can’t supply those then look elsewhere.
You will also have to demonstrate hardship. If you have other assets, the likelihood of the lender taking a short sale is also slim. Depending on the laws in Hawaii and the type of loan you obtained, the lender may have a legal right to attach your other assets to obtain the money you owe. Speak to an attorney who understands this part of the law; it is illegal for your real estate agent or broker to give you this type of advice.
Depending upon your current financial situation, you may be better off selling the properties outright and taking the loss. For instance, one of our limited liability companies (LLCs) had an operating loss for 2008. Our CPA advised us of a change in the tax law that allowed us to apply that loss against the income we had in an earlier year.
We chose a year where we paid the maximum amount in taxes and carried back that loss. The result was a healthy refund for 2006. Again, it will take a CPA or tax attorney to determine which way will net you the most money in the long run. …CONTINUED
Everyone knows that if you do a short sale or foreclosure, or go bankrupt, you will cause substantial damage to your credit rating. Sometimes it’s tempting to consider giving the keys back to the bank, but in the long run it could cost you much more than the loss of the property.
The consequences of poor credit in today’s market are more serious than ever before. Currently, people with great credit are having their credit lines cut off or lowered. Even with almost perfect credit scores (800 or higher), many buyers are having difficulty funding refinances or obtaining purchase-money loans.
If you do obtain a short sale or a loan modification, you will end up paying much higher rates for the next seven to 10 years for just about anything you buy. This translates into higher costs for consumer credit, including car loans, credit cards and future real estate loans.
You must weigh the short-term effects against the extended effects of poor credit. It will also seriously restrict your ability to buy future investment properties.
The federal government, through the Mortgage Debt Relief Act of 2007, does offer some tax relief to those who lose their homes to foreclosure or short sales.
This legislation, according to the Interenal Revenue Service, "generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief," and this relief applies to debt forgiven from 2007-12.
Given that there are so many great foreclosure and short-sale deals in today’s market, a final solution could be to sell and then invest in another property where the cash flow is better. You could also consider doing a "lease-to-own."
The late Bob Bruss, a former Inman columnist and attorney, wrote a report on how to do this (available for purchase at Inman.com). In that report he outlines the pros and cons of this approach. He also provides a clear explanation of what is involved, as well as specific examples of advertising to use.
Before making your final decision, make sure you have investigated all these possible solutions to the issue you are facing. Doing the investigation now can save you years of grief in the future.
Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, trainer and author of "Real Estate Dough: Your Recipe for Real Estate Success" and other books. You can reach her at Bernice@RealEstateCoach.com and find her on Twitter: @bross.
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