A “deed in lieu of foreclosure” is the legal transfer of ownership of real property to the primary mortgage holder. The deed in lieu of foreclosure, sometimes simply called “deed in lieu,” is an option to avoid foreclosure. A deed in lieu conveys the homeowner’s interest in the property back to the lender, usually in exchange for forgiveness of mortgage balance. Deeds in lieu of foreclosure are an effective way for both the borrower and lender to avoid costly and lengthy foreclosure proceedings.
There are no guarantees that a mortgage company will accept a deed in lieu of foreclosure. Every property is different. Both the homeowner and the mortgage company must enter into the transaction voluntarily and in good faith.
Historically, mortgage lenders did not allow deeds in lieu if the outstanding balance on the mortgage exceeded the fair market value of the property. Today, lenders are increasingly accepting deeds in lieu to avoid the costly foreclosure process. Until the final agreement is executed, neither the borrower nor the lender are obligated to proceed with the deed in lieu.
Advantages of the Deed in Lieu of Foreclosure
If you have defaulted on your mortgage and are considering surrendering your home, then you should keep the deed in lieu option on the table. The goal in deed in lieu negotiations is the full forgiveness of the mortgage balance. A deed in lieu of foreclosure is much less costly to the mortgage company. And it is much less damaging to your credit than a foreclosure. The process can often take many months, yet is shorter than foreclosure proceedings.
Tax Implications with a Deed in Lieu of Foreclosure
The IRS considers forgiven debt to be taxable income. Deeds in lieu of foreclosure are considered “debt cancellation income.” In some circumstances, income tax will be due on the debt cancellation income resulting from a deed in lieu. In many cases, however, you will not owe income tax as a result of a deed in lieu of foreclosure.
If you are insolvent when the debt is cancelled, some or all of the cancelled debt will likely not be taxable to you. You are considered insolvent when the total of your debts is greater than the total of the fair market value of your assets. In some cases, however, insolvency can be fairly complex to determine.
Most homeowners’ total net worth is closely related to the equity in their homes. Homes transferred using a deed in lieu of foreclosure are usually under water. (That means that you owe more on the mortgage than you could obtain in the open market.) In these situations, the IRS will likely consider you to be “insolvent” for tax purposes. For many homeowners, the deed in lieu of foreclosure will not trigger tax liability.
Contact an Attorney to Learn Your Options
Homeowners facing foreclosure will have a better chance success obtaining a deed in lieu of foreclosure by hiring an attorney. Negotiating the process is often tricky and time-consuming. Lee Legal frequently negotiates with mortgage companies for deeds in lieu, short sales, and modifications. A good first step is to schedule a free consultation to discuss your options.