Deed in Lieu = Foreclosure
What is a “Deed in Lieu of Foreclosure” aka “Deed in Lieu”?
A Deed in lieu of foreclosure is a process in which the home owner deeds their property to the underlying lender in lieu of the lender going through the foreclosure process. Once the title to the property is conveyed back to the lender, the lender then sells the property in order satisfy the loan that was previously secured by the property.
How does deed in lieu work?
When you request a Deed in Lieu in order to avoid foreclosure, you need to sign legal documents such as the Agreement in Lieu of Foreclosure and a Warranty deed, quit claim deed or a grant deed. The first document reveals the terms and conditions of the deed-in-lieu, and is signed by both the lender and borrower. The second document, which is the deed, conveys legal ownership of the property to the lender. There can be no other encumbrances against the property for a lender to accept a Deed in Lieu: no liens, judgments’, past due property taxes, unpaid equity lines, past due HOA fees, utility liens, IRS liens, State tax liens, child support liens, etc.
The lender marks the borrower's note as "paid" and provides the latter with two forms - one which states that the debt is canceled and the other which refers to the waiver of any right the lender may have to a deficiency judgment. A deficiency is the amount of the loan not paid back to the lender by the subsequent sale of the property.
The agreement for deed in lieu of foreclosure is executed through an escrow company which receives the borrower's note (marked as "paid") from the lender. The escrow then records the deed used for transferring legal ownership of the mortgaged property and sends the note to the borrower. The borrower is thus released from the liability of the mortgage debt.
What are the tax consequences?
A Deed in Lieu, may involve 2 types of taxes for the home owner. These are:
- Deed tax: Since deed in lieu of foreclosure involves the transfer of property, the borrower needs to pay state deed tax upon conveyance of the property to the lender. The tax is calculated on the difference between the fair market value of the property and the mortgage balance plus any liens removed from the property due to the terms and conditions of the deed in lieu. This will vary from State to State and county to county.
- Income tax on canceled debt: As per the “Mortgage Debt Forgiveness Act of 2007” (applicable until the end of 2012), there is no taxable event on the canceled debt. The cancelled debt is the amount unpaid by the proceeds of the sale of the property. However, a borrower needs to satisfy certain conditions for cancelled debt tax relief.
Why consider a Deed in Lieu of Foreclosure?
There is really no good reason to consider a Deed in Lieu of Foreclosure as long as a Short Sale alternative to Foreclosure is available to the borrower. On the “Credit Buster” scale a Deed in Lieu of Foreclosure is equal to a foreclosure: the worst thing you can have reported on your credit report. A Short Sale is the least damaging to your credit, and in fact has no effect on your credit score after 24 months; whereas, a foreclosure and Deed in Lieu will adversely affect your credit for 7 years.
