Consequences of Strategic Default

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A strategic default is strategic business decision to discontinue paying on a loan when it no longer makes financial sense, i.e. when a property declines significantly in value. Without proper legal oversight, strategic default does have consequences.

If the borrower lives in a recourse stateThe following states are Recourse States, where the borrower remians liable for the loan deficiency: Alabama (AL), Arkansas (AR), Colorado (CO), Delaware (DE), District of Columbia (DC), Florida (FL), Georgia (GA), Hawaii (HI), Illinois (IL), Iowa (IA), Indiana (IN), Kansas (KS), Kentucky (KY), Louisiana (LA,Maine (ME), Maryland (MD), Massachusetts (MA), Michigan (MI), Montana (MT), Mississippi (MS), Missouri (MO), Ohio(OH), Nebraska (NE), Nevada (NV), New Hampshire (NH), New Jersey (NJ, New Mexico (NM), New York (NY), Oklahoma (OK), Pennsylvania (PA), Puerto Rico (PR), Rhode Island (RI), South Carolina (SC), Tennessee (TN), Vermont (VT), Virginia (VA), West Virginia (WV), Wisconsin (WI), Wyoming (WY). , if the property cannot be sold for an amount sufficient to pay off the entire indebtedness, a lender may file suit for a deficiency judgment against the property owners, where the borrower remains liable for the difference between the amount owed and the amount received at sale. Once a judgment is obtained, the borrower’s assets that are not adequately protected may ultimately be seized and liquidated by the judgment holder.

Additionally, the difference between 1) the value of the property at the time of foreclosure or short sale, and 2) the amount of the note (assuming the note is larger) is considered by the IRS as “debt forgiven” and treated as taxable ordinary income. This entire amount may be considered income subject to federal income tax if the property is not your principle residence. There is an exclusion in place only for foreclosures taking place until December 2012 due to the Mortgage Forgiveness Debt Relief Act of 2007, but this DOES NOT apply to second homes or investment properties.

We mitigate BOTH of these consequences by properly negotiating with your lender so that your assets will not be subject to seizure, AND prepare exclusions under certain circumstances as an alternative to the 1099. While most attorneys and tax preparers will simply include the 1099 generated by the bank as income, we will work with your tax advisor and, if necessary, prepare a tax opinion to support our basis for exclusion of income if audited by the IRS.