Bankruptcy Tip #1: Timing Is Everything

Many legal rights can be lost through delay. This is particularly true in bankruptcy. Here is just one example that highlights how one area of the bankruptcy law is extremely time sensitive. And there are many more, some of which we will highlight as we go along.

Many legal rights can be lost through delay. This is particularly true in bankruptcy. Here is just one example that highlights how one area of the bankruptcy law is extremely time sensitive. And there are many more, some of which we will highlight as we go along.

Many owners of real estate have experienced or are contemplating a “short sale”; that is a sale of real property for an amount less than the secured indebtedness against the property. Let’s say for example an interest in real property such as a house is to be sold to a buyer at the going fair market value of $500,000. If there is $600,000 of debt secured by the property, the property is “short” by $100,000 of satisfying the debt secured by the property. In order to allow the sale to go forward, lenders often will “forgive” the repayment of some, if not all, of their debt repayment since the property is not being sold at a price that will repay the entire amount of the lender’s debt. This may seem on the surface to be the perfect solution. A property owner can sell a property that is “underwater”, get relieved of the payments on the property, and have the lender forgive some or all of the debt. What could be better? Right? Very possibly wrong!

short sale

Since a successful short-sale will ultimately reduce the debt of a hshort saleomeowner, the IRS considers the reduction of debt as income.

The cancellation of debt, or COD, as it’s known in tax circles, can result in an income tax that is based on the amount of debt cancelled. Here is the bankruptcy angle: a bankruptcy filed before a short sale resulting in a cancellation of debt (COD) will not incur a COD income tax. A bankruptcy filed after the short sale will not prevent the tax.

A case in point. Referred to me by an astute real estate agent five days before a short sale, a distinguished gentleman came to my office on a Friday afternoon. The short sale of his former residence was to close early the following week. Working on an emergency basis with his real estate broker and accountant, we were able to get the close of the short sale postponed until after my client had filed a Chapter 7 bankruptcy. Why? This client’s situation was such that if the short sale had occurred before his bankruptcy was filed, he would have incurred a non-dischargeable IRS COD tax estimated at $250,000.

By taking care of the legalities to the complete satisfaction of buyer, agent and my client, the sale took place after the client’s bankruptcy discharge was obtained, which took place just 90 days from the bankruptcy petition filing. It was a Win-Win-Win all around, but particularly for my client who was unlikely ever in his life to be able to repay a $250,000 IRS tax liability. Timing was the key. Had the short sale gone through before the client came to our office, the result would have been much different. We had a very happy ending to this story because of timing. Only the IRS lost out. But nobody was shedding crocodile tears. So in the economic sense at least, delay can be deadly. Timing is everything!


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