Or maybe this is just a continuing, disappointed sigh that this group, who tries to build a profession around selling houses, is itself oversold.

Latest example arose where a homeowner was referred to me by his accountant, concerned about a pending short sale of the client’s home.  By our rough calculations, the short sale of the house would trigger about a quarter of a million dollars in forgiveness of debt income.  After discussing it with the client, we called his realtor who had negotiated this sale without discussing a quarter of a million dollars in phantom income to the client hidden in the deal.

When I explained my concern, the realtor’s come back addressed the capital gains tax exclusion for homeowners!  He apparently knew nothing about the tax consequences of a short sale, especially one that didn’t qualify for the special provisions recently enacted.  Worse he seemed indifferent about the adverse impact on his client.

Seems to me the essence of a profession is an institutionalized concern for the client/patient that trumps the self interest of the professional.  I don’t for a moment argue that realtors ought to be giving tax advice;  I do argue that they ought to be able to spot common tax issues and direct the client to an expert.  Here, the realtor was clueless and exposed the client to being blind sided by a huge tax obligation.

A professional has to do better.

Two trends in the housing crisis are intersecting in my practice:  we’re seeing more loan modifications, all the while we see more and more homeowners with whopping negative equity. The question I’m asking each client eager for a modification is “what do you expect for this property five years from now?”

Most loan modifications are simply tacking the arrears to the loan principal and lowering the interest rate for some time.  With a property already worth more than is owed, the arrearage gets capitalized, and the loan principal increases.

When the homeowner owes more than the property is worth, the only way that property can be sold or transfered is by short sale (if the lender agrees) or by foreclosure.  The homeowner is now chained to the property and any disposition of that property in the near future will involve either a protracted negotiation with the lender or a foreclosure and a further hit to the borrower’s credit report.

There are several moving parts in this problem:  how great is the deficit?  for how long will the property be appropriate for the client?  how does the mortgage payment in the modified loan compare to the cost of renting?  Each different combination of factors produces slightly different  analysis.

But the underlying issue remains:  the real property is not really an investment any longer, even with a modified loan.  It is a place to live presumably at a price you can afford today.  When it is no longer affordable or appropriate, you will have a property that is essentially unsaleable in the  conventional manner.

For many clients with loan modifications, we are just kicking the underlying problem down a road a ways.

What is obvious to me is that the

While the federal tax law carved out an exception to the tax on cancellation of debt income when it involved the taxpayer’s home, the state of California did not move to conform its tax law to federal law.  Those who lost their homes to foreclosure faced state taxes on the phantom income.

California conformed its law to the federal treatment of forgiveness of debt income this week.  At least California has moved away from kicking taxpayers when they are now.

Now if someone would enact an effective, balanced approach to mortgage modification that considers principal reduction.  Otherwise, I continue to advise clients to walk away from houses they will never be able to sell for enough to pay the mortgage.

The clients in financial trouble couldn’t get the attention of their mortgage lender about the coming train wreck.  But you’re current, said the telephone representative for the lender.  So, the clients deliberately missed a payment to make their point that they needed help.

Care to guess what happened next?  Determined to remain only one payment down, they sent the next payment, and IT WAS RETURNED.  It was followed by a notice of default.

So now the clients are talking to bankruptcy counsel and are looking for ways to get the constructive attention of PNC Bank.

The would be client had millions of dollars of equity in the house at stake, yet waited til the week of the foreclosure to look for a bankruptcy lawyer.  The required case would be a Chapter 11, which is heavy on procedure.  I didn’t have the capacity to take on such a case on an emergency basis.  Neither could one of my most esteemed colleagues.

How did the homeowner get into this bind?  He’d been trying to negotiate a resolution and a modification right up to the last minute, and at the last minute, the lender said “no”.

I’d like to report that this scenario is aberrational, but it isn’t.  I am not seeing many accepted modifications or even workouts, much less ones that actually improve the homeowner’s situation.  If you are facing foreclosure, don’t bank on positive response from the bank if you envision bankruptcy as the last ditch choice.  There may no capable bankruptcy attorneys available who can turn a case around in less than a week.

Several clients have asked whether they can remove personal property from their home while it’s “in foreclosure”.  Another client wanted to know what the rights of the foreclosing creditor were to come into her home before any sale was held.

Be clear:  it’s your property until there is a foreclosure sale. Your rights to the property are unchanged by any default on the mortgage payment.  Likewise, the lender is still an outsider unless and until it obtains title to the property by being the highest bidder at the foreclosure sale.

I’m fascinated by the concept of being “in foreclosure”.  It seems to be akin to being  ”in collections”.  Neither are real places, or even changes in your legal rights.  Yet laymen seem to think of them as situations in which the rules change and consequences follow. [ I have a mental image of them being dank dungeons with manacles on the wall, and cobwebs hanging from the beams.]  True, that each represents a process that may lead to a change in legal rights, or a loss of property, but they are roadways, not fixed “places.”

The foreclosure process, which by California law, takes a minimum of  four months from formal notice of default to foreclosure sale, is being drawn out these days,  by the action or inaction of the foreclosing creditor.  My assumption is that their systems simply can’t process that many foreclosures and the market can’t absorb that much bank owned property.

Which brings me to my current favorite sermon:  even if it’s inevitable that you lose the house to foreclosure, stay in the property and live payment free until there is actually a sale.  You may be astounded at how long that interval is, how very much longer than the four month legal process.

One of the mysteries of the universe (well, sorta) was answered for me this month when the UST’s office wanted to adjust the taxes incurred on the B-22 for taxes as they were projected to be in the future.

My position has been that current income is the only part of the means test calculation that was determined by looking backward.  By statute, Congress defined “current monthly income” to be backward looking. (Conclude what you will about Congress.)  Expenses remained forward looking.

So, if the debtor expected to surrender real estate and lose the interest deduction, their taxes should be calculated, not on what they might owe this year, when they still had the deduction, but looking forward to their tax obligation post surrender of the property.

Others have wondered whether the taxes ought to travel with the income in the look back period.  At some level, that’s logical, since it defines how much income the debtor has that is disposable, in the broadest sense.  [If you've followed my views on the means test, you will know that any argument about the means test based on logic is per se faulty!]

In my recent case, the UST stated clearly that taxes were a forward looking expense. Of course in my case, where I had increased the tax burden to reflect the fact that in 09 the debtors had not paid all of the mortgage interest due and would therefore have a smaller deduction than in past years, the UST wanted to look further forward to years in which they would be paying mortgage interest as it came due.

You had to know that any little victory would be diluted by the UST’s world view, didn’t you?

The automatic stay is the hallmark of bankruptcy, so when the judge lifts the stay to permit a lender to foreclose, we tend to think the curtain has come down on our client as homeowner.  Well, maybe not, or at least, not yet.

In some cases, the road to foreclosure seems to be a wandering path rather than an expressway.  Case in point:  relief from stay was granted in my client’s case on April 15th.  The notice of default, the first step in the statutory foreclosure process, was not recorded until six months later.

Those six months are months the clients lived payment free in the house.  They continue to try to wend their way through the lender’s loan modification process.  Even if they aren’t successful in getting a modification, it will be at least another 4 months before the lender can hold a foreclosure sale.

This is a recent example that reinforces a story I’ve told before, about the client who moved his family out of their large comfortable home as soon as he saw they could not keep it.  They rented a house, and worked on preparing for a bankruptcy filing.  More than a year later, when we were ready to file, the lender had still not taken the first step in foreclosure.  Twelve months the client paid rent, when he could have stayed where he was, at no cost.

Falling home prices have lead to a surge of strategic defaulters, in real estate columnist Kenneth Harney’s words:  people who abruptly choose to stop making mortgage payments.  These folks have made an economic decision that continuing to pay on a house that is significantly underwater does not make economic sense.

Harney is clearly bothered by this choice by people who appear to be able to make the payments, but elect instead to default and lose the property.  In this and an earlier column, he raises the question of the morality of  elective mortgage default.

I’ve been chewing on that idea:  is there a moral issue when a borrower voluntarily defaults?  The law attaches  consequences to certain promises, such as the promise to repay money borrowed.  If the borrower is capable of repaying but does not, is that a moral failing?  Or is it nothing more than the weighing of the consequences of shunning a legal duty vs. the cost of performing the promise?

I tried thinking about this from the lender’s side of the transaction:  are there any moral obligations that the lender assumes when they make the loan?  Could the lender exercise a legal right (to foreclose, say) and yet violate a moral precept?  (All of this presupposes that corporations have morals, or moral duties, of course.)  Would a lender have a moral obligation to modify a loan in the absence of a legal obligation?

Or, is all that is involved in the mortgage loan transaction the undertaking to expose yourself to certain unpleasant consequences if you default?

It bears more thought.  I routinely ask bankruptcy clients whether it makes sense to continue to pay on mortgages where the loan balance is significantly greater than the property’s value.  I want them to consider the option of walking away in the course of the bankruptcy.

I saw another facet of the underwater home mortgage when my client was considering whether to cure the mortgage arrears or walk away.  If he cannot hang on to the property until it regains the $85,000 negative, he will not be able to sell the property in the future without the active cooperation of the lender for a short sale.  After our current experiences with lenders and underwater properties, who wants to bank on that?

The homeowner was a single man and the property was a one bedroom one bath condo.  Life wouldn’t have to change much before a 1 and 1 is too small for a married man.  He’s filing bankruptcy now and will take the credit hit and get on the way to a fresh start.

If he elects to keep the condo and cure the arrears, he sets himself up for another possible credit hit when he needs to sell a property still underwater.