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Posted by on Jul 3, 2008 in Walkaways | 17 comments | Print Print

Walkaway x 7

 

blog%20274.jpgAll types of homeowners are thinking about walking away – in this case, the builders of the seven new homes on Newland Ct. in Carlsbad formed an LLC so they’ll probably dodge the ruining-of-credit problem. 

Too bad they didn’t sharpen their pencil a little sooner on their prices.  When they started selling these in the summer of 2006, they were looking for $1.4 to $1.5 million, and when the first set of listings expired at the end of 2007, they were down to $1.2 million.  But buyer expectations were either dropping faster, or close to non-existent for 3,500 sf homes that back to Carlsbad Village Drive.

The current listings on the Newland Seven are on the range $895,000 to $995,000, but too little, too late.

The lender, United Commercial Bank, is foreclosing on their $6.4 million loan, and had their trustee sale scheduled for today – but it postponed to next month.  The profit was too tight – so their business decision became obvious – they decided to walk too.

The walkaway option will occur to many, and there’s not much to stop people.  I think the LLC will be obligated to pay tax on the loss endured by the lender – wasn’t the tax relief offered only to those who owner-occupied?

Should the government reverse the decision on not taxing the money lost by the banks by owner-occupiers?  That decision really opened the floodgates, and it’s probably too late to turn back now.

 

17 Comments

  1. "I think the LLC will be obligated to pay tax on the loss endured by the lender – wasn’t the tax relief offered only to those who owner-occupied?"

    I am no accountant, but 1) if the construction lender takes all 7 improved properties back with a full credit bid, my understanding is there is not necessarily cancellation of indebtedness income. Insolvency may be another exception. There may be a capital gain, or loss, but that is a different question; and 2) to the extent the LLC has accumulated net operating losses, it may just wash out. Tax issues are probably the least of these guys worries.

    And my guess is that the tax relief legislation for owner occupiers "acquisition indebtedness" is more of an after thought than a driving force for walk aways. Cancellation of indebtedness taxes on owner occupied residences is really a stupid penalty for a homeowner who gets stuck in a declining real estate market. IMHO, the relief legislation should become permanent and even expanded. Collecting taxes on phantom income is unfair tax policy.

  2. Those houses are so hideous I can’t imagine anyone paying over lot-value for them. For my $700k I’d prefer to own something that didn’t cause me to vomit upon sight.

    I’ve heard of several developments in Riverside where the builders walked away before even finishing the houses. Has there been any of that in SD? I wouldn’t be surprised to see it before this mess is over.

  3. As most of you know, I was the listing agent of the lot when it sold to these guys. It was known at the time of purchase that the buyer was made of money, so this LLC was a convenient device for him to skate out with no personal obligation.

    I can see your point, Kingside, about the unfair tax on phantom income. Hopefully from now on the lenders will be making loans to better-qualified buyers, and there won’t be a need to worry about so many defaults. The commercial banks will be having second thoughts about lending to LLCs too.

  4. I’m not sure what the current status is, but the builder, Barratt, in Bressi Ranch has closed their Maganolia Estates sales office and B of A has filed foreclosure notices ontheir properties for $75M . How much of this is tied into the Maganolia Estates development there, I don’t know.

    But there are at least five (maybe 7 or 8?) finished houes there that don’t show up in the tax records as sold, and two not-finished ones. There’s another five or so that are still just lots.

    Don’t know if they will walk away, go bankurpt or work out some refinancing, but it doesn’t seem good that the bank officially filed….

  5. Apologies for all the typos….

  6. "As most of you know, I was the listing agent of the lot when it sold to these guys. It was known at the time of purchase that the buyer was made of money, so this LLC was a convenient device for him to skate out with no personal obligation."

    Jim, I would not assume he will skate. In the commercial context, the lenders typically will get personal guarantees when lending to an entity such as an LLC, and as recently as a week ago, a California Court of Appeal affirmed the validity of a personal guarantee deficiency as not necessarily wiped out by the one action foreclosure rule. Suffice it to say that this topic can get very complicated.

  7. Kingside, your point would make sense to me as "policy" if the fed would let people write-off capital losses on personal residences (as already possible for rental/business properties), but for now they don’t. Would you want the more responsible person who made a down payment that gets wiped out get no tax break on the loss, while the zero-down, no skin, walk away guy does? Way unfair and bad policy. But, so are lots of things when it comes to government.

    That loans should be "tax free" is quite a concept. Do banks get to write off the bad debt without anyone accountable for the "profit". Just home loans? What about credit card loans? Any loan? Hey, forget about the personal income tax system. People will instead "work for loans" in the future, which they will conveniently not pay back, tax free!

    "Phantom income" implies that the buyer did not in fact borrow the money and spend it on a house, but instead the bank bought the house, and the "borrower" is just a passive bystander who stands to get the upside (tax free $250K/$500K) but no downside (after all, would be "unfair").

  8. You are correct Kingside. I am in the process of acquiring a commercial property with a few partners and although we plan on taking title to the property as an LLC we were all required to personally guarantee the loan. It was presented to us very matter-of-factly that this requirement was not negotiable.

  9. I have a good friend that does Commercial C&D loans as a VP at a bank.

    They NEVER make a loan to an LLC without personal guarantees that pierce the veil of LLC liability protection.

    It isn’t negotiable.

  10. If you are on the hook, personally, why let it go into foreclosure? In this case, the owner has plenty of dough. Could he be doing it to shake off some partners? It’ll be interesting to see what happens at the trustee sale. There was speculation that the owner wanted to short-sell the bank, and this could be a ploy to effect the same.

    They postponed the sale yesterday, so maybe the bank is trying to negotiate a settlement. I doubt they want the property.

  11. Ironically, one of the ways you try to defeat liability on a personal guarantee of a real estate loan is to contend that you are the alter ego of the entity (LLC, corp) debtor, and that you are entitled to the same anti-deficiency protection of the debtor. This stuff can get very convoluted.

    For those nerds who want to learn the latest on this stuff, a very recent published California case, Talbot v.Hustwit (June 21, 2008) discusses this in excruciating detail. It can be found on the web @

    http://www.courtinfo.ca.gov/opinions/documents/G037424.PDF

  12. Happy 4th Jim – hope you and your family are well.

  13. Jim why would you ask a question about slowing this down? The worst thing that can happen is to slow down the tsunami. The damage is done. It was done when the mortgages were inked, liars were consummated and fraud became the norm. Now all that is left is to rip off the bandage. Fast or slow its coming off.

  14. As others have already said, it’s not really likely that the bank didn’t get a personal guaranty. In many cases, when the people at the bank are smart, they will also require security interests in other properties so the bank can foreclose on those and get paid without having to sue. A well-written agreement will even allow the bank to foreclose on the other properties first. Of course, this happens only when the people at the bank are doing their jobs well.

  15. Barnaby33,

    Have you ever thought about starting your own blog?

  16. Is that the polite way of telling me to get lost? I’ll admit it Jim, I’m lazy. Otherwise I’d do it. I don’t have enough new ideas to really constitute a blog, I leave that to deeper thinkers like Rich, Ben, Mish, CR and you.

  17. Until all the bad loans are purged (homes foreclosed, total losses written off at the banks & various financial entities, etc.), there will be downward pressure in the housing market and general economy.

    The people and businesses who were wise enough to save money during the boom years can only hold out for a limited amount of time during a recession/depression. The longer this is made to drag on, the longer we will be in a recession/depression, and it will be more likely that even the entities who did everything right (saved and avoided bad investments) will end up going under.

    The sooner we get this over with, the better. We need to right the economy and get back to productive business instead of swapping money back and forth. As long as there is excess credit/debt, we will not be able to correct all the imbalances. It will be painful no matter how long it takes, but a shorter recession/depression will be much better than one that drags on for decades.

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