Purchase & Sale Agreement - Specifics for Short Sale

[100K/Month]

Good morning!

I am about to sign Purchase and Sale Agreement with homeowner, which will be included as part of the short sale package.  The homeowner is the only one on the deed and is currently in foreclosure.

1. Are there specific provisions or clauses that should be included in the contract to protect me (investor) after a short sale?

2. Are there other documents that I might need signed by the owner?

For example, I was thinking of having a lawyer prepare a disclosure document to officially notify owner that the bank has a right to go after the deficiency through court; otherwise, the deficiency amount will be reported as income on 1099 and will be subject to income tax.

Any advice / "thinking points" are appreciated!  Repsonse such as:  "I don't do anything different" is also of help.

[Dave T]

You should probably consult your attorney to address your legal questions.   As to a disclosure, I would not put myself in the position of trying to give tax or legal advice.  The most you should do is advise the seller to consult his tax advisor to determine whether there MAY be income tax consequences as a result of this sale.

You don't know that there will be.  You don't know that the lender will issue a 1099.  You don't know that the lender will seek a deficiency judgement, and then, get it recorded.   You don't even know that the lender will accept your short sale offer.

[100K/Month]

Well, I am not suggesting that I know that these things will happen; rather I am merely planning to disclose that such consequences are possible.  Nor do I or my attorney plan to advise the seller on legal or tax issues.

However, it is a risk, which I will illustrate by the following example.  My short sale offer is approved and I happily flip the property pocketing 80K pre-tax.  After some time, I am sued by former homeowner because the bank issued 1099 for 55K of income to her (forgiveness of debt = the bank did not bother with a deficiency judgement).  Now that the homeowner has to pay 14K in taxes, she is suing me on the following grounds:  fraud.  More specifically, evil educated investor took advantage of the difficult financial situation of the uneducated homeowner, who at the time thought that she was completely done with this property and can move on with her life.  More importantly, she thought that she owes nothing, which turned out to be wrong.

So, the questions are:

- Is this scenario possible?  I think so, but would like to hear anyone’s opinion.

- If yes, how can an investor protect own interests in this situation?

[Dave T]

Is the seller insolvent?  If so, then there is no federal income tax liability due to debt cancellation even if the lender issues a 1099.  

The best you should hope to do is to advise the seller that there MAY be income tax consequences that the seller should fully explore with his/her own tax advisor.

Rather than your fraud scenario, I would think that you risk being sued because you made such a large profit.  The seller will think that a large portion of that would have been hers had you not taken advantage of her situation and coerced her to sell on such unfavorable terms.  Her lawsuit will seek to claim some of that profit for herself.

By all means consult your attorney, just don't put yourself in the position of trying to give the seller tax or legal advice beyond telling the seller to consult with a tax professional on the possible tax consequences of this deal.

[100K/Month]

Thanks for a reply.  Fair enough.

But this is rather puzzling:

Rather than your fraud scenario, I would think that you risk being sued because you made such a large profit.

Really?  What's large?  Don't mean to be a pain (and it seems that no one else has any opinion), but all I am trying to do is to protect myself in such transaction and try to avoid as much risk as possible before anything is signed.

[Dave T]

What's large?

I don't know what is large to you.  It's all relative, but an $80K profit (your number) seems fairly large to me.

Don't assume that no one else has an opinion.  It may be that everyone else MAY agree with the answer you have already been given -- the specific legal advice you are seeking should come from your own attorney.

[100K/Month]

Um, I don't know - on a 800K property 10% of value pre-tax profit seems not very large.  Nonetheless, you are right - it's all relative.

But what's with all the hostility?!?!  I didn't assume anything and just asked for other's opinions in the forum titled "Asset Protection, Legal and Contract Issues, Income Taxes, 1031 Exchanges".  I wonder what kind of questions can one ask and get someone else's opinion besides:  "Call your lawyer".  Isn't the whole point of this specific forum is to discuss legal issues and inform others about them, give legal advice and share opinions?

Anyway...  Thank you.  I guess.

P.S.  Don't assume that everyone else has the same opinion as you.