Q: I have a real estate/bankruptcy question for you. I purchased a beach property in North Carolina with a friend a couple of years back. We put down 10 percent and financed the rest.
We thought we could sell the property quickly, but we were wrong. The co-owners have been having financial problems and stopped paying their share of the mortgage, taxes and insurance about two years ago. Since then, they have been paying the utilities and I’ve paid everything else.
We are able to rent the property during the high season and periodically during the off season and cover about 60 percent of the expenses but we lose money on the whole. Our property is about 20 percent underwater.
Although I’m able to continue covering the monthly expenses, I’m stretched pretty thin. If the rental income doesn’t continue at the same level (or if anything breaks), I might not be able to cover the payments.
I recently received notice that the co-owners have filed for bankruptcy. Should I consider a short sale, loan modification, bankruptcy, or deed-in-lieu or even bankruptcy?
A: You have an interesting question in that the property you are dealing with isn’t your primary residence, but rather an investment property. Let’s go over the variety of issues you face.
Ideally, if you can find a way to rent the property more days and cover all of your expenses, your problems would be simplified. Have you considered using the Internet to market the home?
You can use a site like VRBO.com to list your vacation home and set up a page with pictures to market the home to vacationers and renters. You could even use Craigslist or Zillow.
If there is a rental company in your area or one that specializes in your development, you might want to consider having them list the home for rent, and then paying them a portion of the proceeds.
Using as many methods to market your home to the most likely people willing to rent your home would be the best thing you can do to help your situation.
If you are actively marketing the home in all these directions, and haven’t been able to increase the number of days that you rent the home, your next choice is to continue to make the payments and lose money on the investment on a monthly basis until your situation deteriorates or improves.
But you should talk to an accountant if your situation gets worse. In some cases, and depending on your federal tax situation, you might be able to get a tax benefit from your rental losses. While you may not be able to get a tax benefit from all of losses you sustain on a yearly basis, it might at least help a bit. But you won’t know until you consult with your tax preparer.
Taking advantage of any federal income tax benefits could soften some of the blow from your losses. But if these losses are unmanageable to you, then your financial situation is probably pretty dire and you’ll have to consider drastic measures.
If you’re drowning financially under the burden of owning this investment property, you might have to sell the property at any cost. You have several choices when it comes to trying to get rid of the property:
- You can list the property for sale and work with your lender in the short sale – that is selling the home for less than what you owe the lender and having them agree to receive that payment in exchange for allowing the sale to go forward.
- If you can’t find buyers for the home and have stopped making payments on the loan owed to the bank, the bank will commence foreclosure proceedings against you and sell the home in foreclosure.
- You can call the bank and try to see if they would be willing to modify your loan by reducing the interest rate on the loan or they could propose a different solution for you that could work for you. In some circumstances, your lender could agree to allow you to transfer title of the home to them in a deed-in-lieu-of-foreclosure situation. Basically you’re giving the keys and the title to the home over to the bank.
One complication you might face through this process is that your co-owner is in bankruptcy. Once a person files for bankruptcy, his assets become part of the bankruptcy proceedings and a trustee in bankruptcy is assigned to administer those assets. That means that any decision that you and your friend would have taken together now must be agreed to by the trustee in bankruptcy.
If you need your friend to work with you in the short sale, deed-in-lieu, loan modification, or any other issue involving his interest in the home, you’ll have to deal with the trustee.
You still need to do what is best for you, but you now have a new entity to deal with in any decision you make on the house. Just remember, if you can’t get the trustee to agree with what you want to do, you won’t be able to get anything done.
Here’s another wrinkle: Now that your friend is in bankruptcy, your lender might come after you for the entire amount owed on the loan. Not only that, if you sell the property short and deficiency judgments are allowed in your state, the lender might go after you for the shortfall from the short sale or the foreclosure. In some states lenders can obtain a judgment against a borrower after a short sale or foreclosure to recoup any loss that the lender may have sustained from the loan.
Finally, if you are able to sell the home in a short sale, keep in mind that if the lender does accept less than the full repayment on the loan, you could be taxed by the federal government on the amount that you are short paying the lender.
Depending on your situation, that tax amount could be quite painful. If this was your primary residence, you wouldn’t have to worry about this phantom income – that is where the federal government claims that the amount that you should have repaid the bank but did not becomes income to you.
Sit down with a real estate attorney in your area to go over each scenario. Talk to your friend and find out what his or her situation is in the bankruptcy proceeding. Once you have more information from your bank, accountant, attorney, and your friend in bankruptcy proceedings, you might have a better picture of what you need to do.