Short Sale and LLC Asset Protection

By

David P. Bonaccorsi, Esq.Bernard, Balgley & Bonaccorsi

3900 NewPark Mall Road, Third Floor

EDUCATIONAL BACKGROUND

Santa Clara University, B.S. ‘83, J.D., ‘86

I1 Duomo, Firenze (Florence, Italy)

LAW FIRM OF BERNARD, BALGLEY & BONACCORSI

David P. Bonaccorsi, Esq.Bernard, Balgley & Bonaccorsi

3900 NewPark Mall Road, Third FloorNewark, California 94560

Phone: 510.719.1888Website: www.3blawfirm.com

Bernard, Balgley & Bonaccorsi is a quality oriented law firm in the Fremont-Newark area of the San Francisco Bay Area, and serves the legal needs of its clients throughout Northern California. Our clients range from individuals to large national corporations that trade on the New York Stock Exchange. Our firm provides legal services in the areas of Litigation, Land Use and Real Estate, Insurance Defense, Business Law, Estate Planning and Probate, Personal Injury and Family Law.

SHORT SALES1. Short Sale: Is the short sale the only or best

alternative to foreclosure?

• Other Options to the Short Sale (Loan Workout; Deed In Lieu of Foreclosure; Short Payoff) – Beware of The Deficiency Trap and The Tax Trap

• Short Sale Results In A Cancellation of Debt (“COD”)

• If considering a short sale, what type of debt is the lender being asked to discharge? Non-Recourse (i.e. Purchase Money Loan) or Recourse (Refinanced First, Equity Line of Credit, a Second)? Recourse to refinance in part the first but in part to pull out equity to pay off credit cards, buy a car or other benefits unrelated to refinancing the purchase money loan? Are their Junior Liens?

2. The Deficiency Trap for the Borrower with the Lender for a COD

– California’s Anti-Deficiency Statutes: No deficiency judgment if lender forecloses on a purchase money loan (e.g., Code of Civ.Proc., §580d.)

– California’s Anti-Deficiency Statutes do not apply to short sales

Avoiding the Deficiency Trap: Lender’s Approval Letter

– Satisfaction and Release of Liability. If all of the terms and conditions of this Request are met, upon sale and settlement of the property, we will prepare and send to the settlement agent for recording, a lien release in full satisfaction of the mortgage, foregoing all rights to pursue a deficiency judgment.

– (But are their junior liens?)

3. The Tax Trap for the Debtor With the IRS or

the FTB for a COD a. Problem: $1 Million Loan Reduced by Lender to $800,000 on a COD. The $200,000

forgiveness of debt was treated as ordinary income. An unhappy surprise to a displaced homeowner who has sold the home in a short sale on terms agreeable to the lender but still owes taxes on the amount forgiven.

i) Ordinary Income: The QPRI Exception Under Federal and State Law

FEDERAL: Mortgage Debt Relief Act of 2007 (Internal Revenue Code, §108(a)(1)(E): Qualified Principal Residence Indebtedness (“QPRI”) is a loan secured by the residence used to acquire, construct or substantially improve the residence. The income relief provided is capped at $1,000,000 in the case of a married person filing a separate return and $2,000,000 for all others. (COD between 1/2007 and 1/2013).

ii) STATE: SB 401 Mortgage Debt Relief Forgiveness (Rev. & Tax. Code,

§17144.5): Maximum amount of QPRI: $800,000 for married or registered domestic partners filing jointly, head of household, single, widow/widower, and $400,000 for married or registered domestic partners filing separately. Maximum amount of debt relief forgiven: $250,000/$125,000. (COD between 1/2009 and 1/2013.)

* EXAMPLE: Debtor (“D”) bought a home for $660,000, subject to a $500,000 non-recourse debt owed to L. The value of the home has declined to about $420,000. L agrees to reduce the outstanding principal obligation to $420,000. D then sells the house to B for $423,000. O keeps $3,000; $420,000 is paid to L.

*If the QPRI exception under both Federal and State Law is applicable (assuming the home is D's principal residence) the $500,000 debt is acquisition debt and is less than $2 million (Federal) and $800,000 (State). As a result, D can avoid COD income.

• Ordering (QPRI does not apply to use of proceeds for purposes unrelated to refinancing the purchase money loan; i.e. to pay off credit cards, purchase a car, or pay for tuition, etc.)

• Resources. IRS Publication Form 4681; CAR: Taxation of Foreclosures and Short Sales.

Capital Gains ($500,000/$250,000 Capital Gains Exclusion for Principal Residences) QPRI and Capital Gains Exclusion apply if borrower occupied the home as his principal residence 2 out of the last 5 years. (Int. Rev. Code, §§108, 121.) Capital gains in excess of the capital gains exclusion may arise for a homeowner who lived in his home for many years where the depreciated value prompting the short sale still exceeds the adjusted basis.

Exemptions [Insolvency and Bankruptcy – 26 USC §108, subds. (a)-(c).]

4. SB 1178 (sponsored by State Senator Ellen Corbett) Anti-Deficiency Protection for Refinanced Property? Vetoed by Governor Schwarzenegger on 9/30/2010

ASSET PROTECTION-THE LIMITED LIABILITY COMPANY (“LLC”)

1. An LLC allows one or more owners to conduct business without personal liability.

2. For income taxes, an LLC is like a partnership for pass-through tax treatment (i.e., avoid double taxation). Double taxation occurs where a corporation (other than an S corporation) pays tax on its income and the shareholders pay tax on dividends received from the corporation.

3. For liability protection, an LLC is treated like a corporation.

4 . Compare an LLC to other business organizations:

– Advantages over Limited Partnership. Pass-through tax treatment like an LLC. But a general partner is personally liable. Limited partners have limited liability but no control over business to protect limited liability.

– Advantages over an S Corporation. Pass-through tax treatment like an LLC but differs from an LLC in its inability to allocate profits and losses (IRC §1366.) Corporate debt does not increase the shareholders’ basis S-Corporations though can only have one class of stock. (IRC §1361(b)(1)(D).) An S corporation cannot have among other things more than 100 shareholders, a corporate, partnership, or a nonresident alien shareholder. The S Corporation cannot be a foreign corporation or a domestic internation corporation.

– Advantages over a Sole Proprietorship. A sole proprietor is personally liable for all of the obligations of the business.

5. Formation and Operation of an LLC– Selecting a Name from California Secretary of State

(“LLC” or “Limited Liability Company” in its name.)– Articles of Organization (LLC-1) – Must be filed w/ SOS

[Corp. Code §17050(a).]– Statement of Information (LLC-12) must be filed w/in 90

days of filing the LLC-1. [Corp. Code §17060.]– Operating Agreement (Great Flexibility for Management

Structure)

- Can be formed for any lawful business activity– Exception: Financial Services and Professional

Services

- One or more members/Managing Member(s).

- Maintain an office in California.

- Minimum Franchise Tax of $800

6. Exceptions to Personal Liability for Members of an LLC

-If set forth in the Articles of Organization or Operating Agreement

Questions??

More questions?

David P. Bonaccorsi, Esq.Bernard, Balgley & Bonaccorsi

3900 NewPark Mall Road, Third FloorNewark, California 94560

Phone: (510) 791-1888E-mail: dbonaccorsi@3blawfirm.com

Website: www.3blawfirm.com