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One of the popular uses for Chapter 13 bankruptcy is to save a person's home from a mortgage foreclosure case. In most cases, the filing of a Chapter 13 bankruptcy imposes the "automatic stay" that stops the mortgage company from proceeding with its mortgage foreclosure action.
Under Chapter 13 bankruptcy, a person is allowed to propose a Chapter 13 plan proposing to catch his mortgage up-to-date over a period of time up to five years. As part of this plan, a person pays part of his mortgage arrearage each month in addition to making his regular monthly mortgage payment. Interest is generally not charged on the back due payments.
The Chapter 13 bankruptcy automatic stay also stops most other creditors from proceeding with their collection efforts. This includes holders of credit cards and personal loans. As part of the Chapter 13 plan, these unsecured creditors receive what is usually a small percentage dividend on their claims.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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As is well known, many home mortgages were sold and packaged into securitizied pass-through vehicles, usually trusts, known as REMICs (Real Estate Mortgage Investment Conduits) which in turn sold certificates to investors around the world. Although securitization presented borrowers with new financing opportunities, it brought with it a set of restrictions due to the Internal Revenue Code requirements that make it difficult for mortgage servicers and their trusts to modify mortgages if the homeowner falls into financial difficulties.
REMICs are tax-preferred entities that hold the securitized mortgages for the investor certificate-holders. The REMIC provisions are contained in Part IV of subchapter M of Chapter 1 of the Internal Revenue Code (sections 860A-860G). The REMIC provisions provide for a pass-through entity that issues multiple classes of interests representing undivided ownership interests in pools of residential and commercial mortgage loans. The certificates are of different levels of investment risk. The income from the mortgage loans in the REMIC is taxed to the holders of the interest in the REMIC.
In order to maintain its tax-preferred status, a REMIC must meet certain requirements of the Internal Revenue Code. REMICs, which are generally trusts, are typically not subject to federal income taxation. If REMICs engage in certain activities they may lose their status as a REMIC and may in some instances be subject to taxation, such as a 100% prohibited transaction tax.
After securitization, the REMIC's master servicer is responsible for collecting payments from the homeowners. The master servicer's responsbilities and authority are provided for a pooling and servicing agreement ("PSA") between the trustee of the REMIC and the master servicer. PSAs provide that the master servicer not take any action that will result in the loss of the REMIC's tax-preferred status. As a result, any request by a borrower for a modification of a mortgage held by a REMIC must be considered in view of the continued preferred tax status of the REMIC. A modification that may be otherwise desirable may be denied due to a necessity of maintaining REMIC tax-preferred status.
The IRS recently released proposed regulations that would expand the circumstances under which modifications of mortgage loans held by REMICs would be permitted.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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In today's financial world, the law regarding the transfer of mortgage notes and mortgages in the secondary mortgage market is quite a relevant topic. Issues may arise of the effect of the assignment of a mortgage note without the assignment of the related mortgage. One may also question the effect of the assignment of a mortgage without the assignment of the related mortgage note.
It appears to be the general rule in Florida that the transfer of a mortgage note transfers with it the related mortgage. The mortgage note is regarded as the principal item with the mortgage being regarded as a mere accessory. 6 Fla. Jur. 2nd, Bills and Notes, Section 123. Hence the adage "the mortgage follows the note." The Restatement (Third) of Property: Mortgages provides a general rule that is accordance with the apparent general rule in Florida but specifically provides an exception to this rule if the parties to the transfer of the mortgage note agree otherwise. The Restatement (Third) of Property: Mortgages section 5.4(a) (1997) provides that "[a] transfer of an obligation secured by a mortgage also transfers the mortgage unless the parties to the transfer agree otherwise." The stated objective of the Restatement is to avoid economic waste to the lender and a windfall to the borrower if the note and mortgage are split rendering the mortgage note as a practical matter unsecured. The Restatement cites the case of Carpenter v. Longan, 83 U.S. 271 (1827) which held that "[a]ll the authorities agree that the debt is the principal thing and the mortgage an accessory."
It is interesting to note that this question of law is not nothing new under the sun. A digest of California law published in 1916 provides various entries that reflect case law that the transfer of a note operates as an equitable assignment of the mortgage or deed of trust given to secure it, in the absence of any provision to the contrary. Vol. 6 The New Complete Digest of the Decisions of the Supreme Court and the District Courts of Appeal of the State of California and of all the Federal Decisions Dealing with California Law, Mortgages V section 111, James M. Kerr (1916).
The Restatement further provides that the recordation of a mortgage assignment is not necessary to the effective transfer of the mortgage note, although an assignee would be "well advised" to record the mortgage assignment.
The Restatement's exception provides that a transfer of a mortgage note is possible without the transfer of the mortgage if the parties so agree, but the effect of such a transfer would be to make it impossible to foreclose the mortgage unless the transferor of the mortgage note is made the assignee's agent or trustee with authority to foreclose on the behalf of the assignee of the mortgage note.
The opposite situation would be presented if a mortgage is transferred without the transfer of the mortgage note. The apparent rule in Florida is that an assignment of a mortgage without an assignment of the related mortgage note is deemed a nullity and creates no right in the assignee because a mortgage is a mere lien incidental to the obligation it secures. 37 Fla. Jur. 2nd, Mortgages, Section 511. See e.g., Sobel v. Mutual Development, Inc., 313 So.2d 77 (Fla. 1st DCA 1975). Vance v. Fields, 172 So.2d 613 (Fla. 1st DCA 1965).
A further provision in the Restatement would appear to inherently agree with Florida's position, but avoids its result in some situations by providing that unless otherwise required by the U.C.C. or otherwise agreed, the transfer of a mortgage also transfers the mortgage note obligation. "Except as otherwise required by the Uniform Commercial Code, a transfer of a mortgage also transfers the obligation the mortgage secures unless the parties to the transfer agree otherwise." Restatement (Third) of Property: Mortgages section 5.4(b).
It would appear that this rule of the Restatement may often only apply to mortgages secured by non-negotiable instruments as the Restatement's exception to its application would apparently apply to mortgages secured by negotiable instruments as section 3-203 of the U.C.C. provides for the enforcement of negotiable instruments only by delivery of the instrument itself to the transferee.
The Restatement comments that the "otherwise agreed" exception to this rule would apply in the context of institutional purchasers of mortgage loans in the secondary market where a mortgage originator assigns a mortgage to an appointed third party servicer while the mortgage note is transferred to the actual investor. In this situation, the agreement and intent of the parties is for the investor to be the owner of both the mortgage and mortgage note despite the assignment of the mortgage to the servicer.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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The case of Am. Bank of the S. v. Rothenberg, 598 So. 2d 289 (Fla. 5th DCA 1992) presented a situation of competing claims to ownership of a mortgage. A mortgage company first delivered the actual mortgage note and an assignment of note and mortgage to one party as collateral for a line of credit. Then the mortgage company sold the mortgage note and mortgage to a second party and delivered to it an assignment and a mere photocopy of the mortgage note. Before the first party recorded its assignment of note and mortgage, the second party recorded its assignment of note and mortgage. Upon the property owner's default, the second party began a foreclosure action against the property owner and also claimed priority over the first party who possessed the actual mortgage note. The second party argued that it had priority over the first party as it recorded its assignment of note and mortgage first even though the second party held the actual mortgage note.
The second party claimed priority over the first party based on Florida's recording statute which provides in part that "[n]o assignment of a mortgage upon real property or of any interest therein, shall be good or effectual in law or equity, against creditors or subsequent purchasers, for a valuable consideration, and without notice, unless the assignment is contained in a document which, in its title, indicates an assignment of mortgage and is recorded according to law." Section 701.02 (1), Florida Statutes (1991).
The court rejected the second party's argument and held that the case was governed by negotiable instrument law found in the U.C.C. and not by the recording statute. The court found that the recording statute was enacted to protect a creditor or subsequent purchaser of land who relied on a recorded satisfaction of mortgage which had actually already been assigned to another party who failed to record it. The court refused to extend the application of the recording statute to successive assignments of mortgages.
The court found that first party prevailed over the second party as it possessed a valid assignment of mortgage and was a holder in due course of the original mortgage note. See Vance v. Fields, 172 So. 2d 613 (Fla. 1965). The court held the mortgage note to be a negotiable instrument pursuant to Section 673.104, Florida Statutes (1991) and that the first party was a holder in due course which took the negotiable instrument free from all claims on the part of any person. Section 673.305, Fla. Stat. (1991).Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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The court in In re Adams, 375 B.R. 532 (Bkrtcy.W.D.Mo. 2007)(Dow, J.) held that the Florida homestead exemption does not have extraterritorial effect. Although the debtors filed for chapter 7 bankruptcy in Missouri, they were required to apply the Florida exemptions as they had not been domiciled in Missouri for the entire 730 days prior to the bankruptcy filing and were domiciled in Florida for the greater part of the 180 days prior to such 180 day period 11 U.S.C. Section 522(b)(3)(A).
The court noted that the Florida homestead exemption found in Florida's constitution at Art. X Section 4 does not specifically provide whether it has extraterritorial effect. The court found that the Florida courts agree with the courts that hold as a general proposition that where the homestead law is silent, it does not have extraterritorial effect. See e.g. In re Sanders, 72 B.R. 124 (Bankr.M.D.Fla.1987)(mobile home located in Tennessee not exempt under Florida law as not located within the State of Florida), In re Schlackman, 2007 WL 1482011 (Bankr.S.D.Fla.2007)(Florida courts construe the Florida constitutional homestead provision to require that the homestead be located within the State of Florida for the homestead exemption to be applicable).
The court refused to follow the case of In re Drenttel, 309 B.R. 320 (8th Cir.BAP2004) which allowed the application of the Minnesota homestead exemption to exempt the debtors' home in Arizona. The court distinguished Drenttel as being based on the interpretation of specific Minnesota exemption statutes and the state's public policy. Furthermore the court suggested that the Drenttel court reached its result in an effort to avoid the inequity of the debtors not being able to claim either state's exemptions. The court noted that BAPCPA added the right for a debtor to claim the federal exemptions if the effect of the domiciliary requirements of section 522 is to render them ineligible for any exemption.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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A very hot topic in Miami is the "short sale". This usually involves a sale to another person with your mortgage company agreeing to satisfy its mortgage with a payment of less than the full amount due. A variation on the short sale is the "short refinance." In a short refinance, a person tries to refinance his mortgage with a new mortgage for less than the full amount owed on his existing mortgage with the existing mortgage company agreeing to take less than a full payoff.
Chapter 13 bankruptcy reorganization may offer some people results similar to a short refinance. If the value of your home has fallen dramatically, like most real estate has in Miami, you may be able to wipe out or "avoid" your second mortgage. For example, if you owe $400,000 on your first mortgage and $100,000 on your second mortgage and your home has fallen in value to $399,000, you may wipe out or avoid your second mortgage as there it is wholly unsecured. That is, there is no value or equity to "secure" it.
If your foreclosure involves real estate that is not your principal residence, you may be able in Chapter 13 bankruptcy to reduce even your first mortgage down to the value of your home in addition to wiping out your second mortgage. You may also be able to lower your mortgage interest rate.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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A mortgage foreclosure may also have federal income tax consequences. One issue is "discharge of indebtedness income." This can be understood as the IRS's attempt to tax you on money you were loaned but are not going to repay. The mortgage lender may be required to report the amount of the cancelled debt to you and the IRS on a Form 1099-C, Cancellation of Debt. Fortunately though there are various exceptions to this rule and even a recently added exception.
One of the exceptions to discharge of indebtedness income is if the mortgage debt is discharged in bankruptcy, including under chapter 7 or under chapter 13. In order to take advantage of this exception, it may be important to file for bankruptcy before the foreclosure sale.
Another exception to discharge of indebtedness income is the insolvency exception. That means if you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. Insolvency generally means that your total debts are more than the fair market value of your total assets.
The new exception if the Mortgage Forgiveness Debt Relief Act of 2007 which generally allows people to exclude certain discharge of indebtedness from the foreclosure or mortgage restructuring on their principal residence. This new provision applies to debt forgiven in 2007, 2008 or 2009. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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Bankruptcy Lawyer Miami - Practice Limited to Bankruptcy
Jordan E. Bublick Attorney at Law is a Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification) with offices located at 11645 Biscayne Blvd., Miami, Florida and South Dade Brand at 10700 Caribbean Blvd., Miami, Florida. Jordan E. Bublick limits his practice to person and businesses in Chapter 7, Chapter 13, and Chapter 11 bankruptcy. The firm of Jordan E. Bublick, P.A. was established in 1985. The firm offers a free initial consultation.
Chapter 7 bankruptcy allows a person to discharge most types of debt while keeping his "exempt" property.
Chapter 13 bankruptcy allows a person to propose a plan of reorganization. It is often used to stop a mortgage foreclosure and to catch the mortgage payments up-to-date. Chapter 11 is used by individuals and businesses to reorganize their debt under a chapter 11 plan.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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Chapter 13 bankruptcy is often used to save a person's home from foreclosure. Under chapter 13, you are allowed to stop the mortgage foreclosure case and catch your mortgage up-to-date. The chapter 13 plan usually involves paying off the mortgage arrearage over a 3 to 5 year period in addition to making your regular ongoing monthly mortgage payments.
If your home has decreased in value, sometimes you are able to wipe out or "avoid" your second mortgage. For example, if you owe $300,000 on your first mortgage and $100,000 on your second mortgage and your home has gone down in value to $299,000, there is no equity or value to "secure" the second mortgage. Under these circumstances, the chapter 13 plan (and related section 506 motion) may provide to wipe out or avoid the second mortgage lien. The $100,000 debt owed on the second mortgage will be wholly unsecured and usually only receive a small dividend like the credit cards receive -- typically around five cents on the dollar.
A certified copy of the order avoiding the second mortgage may be recorded in the county public records to document that the second mortgage is void.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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To start a chapter 7 bankruptcy case, a person needs to file a petition with the United States Bankruptcy Court. Usually the case is filed with the Bankruptcy Court in the district where the person lives. If a person lives in Miami-Dade County, Florida it is usually filed with the Bankruptcy Court in Downtown Miami and if a person lives in Broward County, Florida, the case is usually filed with the Bankruptcy Court in Ft. Lauderdale. The Bankruptcy Court for the Southern District of Florida includes Miami-Dade, Broward, Palm Beach, and other nearby counties.
Besides the bankruptcy petition, the debtor must also file various schedules and statements. Schedule A is a list of a person's real estate, schedule B is a list of the personal property, schedule C lists one's exempt property, schedule D lists the secured debt, schedule E lists priority debt, schedule F lists unsecured debt, schedule G sets forth executory contracts and leases, schedule H lists co-debtors, and schedule I and J set forth income and expenses. A statement of financial affairs setting forth various information is also required.
In order to file for chapter 7, a person usually needs to file a certificate of credit counseling and evidence of payment from employers for the 60 days prior to filing.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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When a person files for chapter 7 bankruptcy relief in Miami, Florida, he is allowed to exempt certain property from his bankruptcy estate. Exempt property generally means property that a person is allowed to keep free from liquidation by the chapter 7 bankruptcy trustee for distribution to creditors.
If a person has lived and been domiciled for a sufficient period of time in Miami, Florida. the person is allow is claim the exemptions provided for under Florida and federal non-bankruptcy law. Florida exemptions include the homestead exemption provided by Article X Section 4 of the Florida Constitution. The homestead exemption is limited in size but not in value unless one of the new limitions on homestead value applies. Personal property is exempt to the extent of $1,000.00 and a further $4,000.00 in cases where a person does not have a homestead. A vehicle is exempt to the extent of $1,000.00 in value. Certain retirement plans and benefits such as IRAs and 401(k) plans are also generally exempt. Other exemptions include social security benefits and worker's compensation benefits.
A chapter 7 debtor claims his exemptions on schedule C of his bankruptcy schedules. If the chapter 7 bankruptcy trustee or other party does not object to the claim of exemptions, they are deemed allowed.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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Jordan E. Bublick is a Board Certified Consumer Bankruptcy lawyer (American Board of Certification) with offices in Miami, Florida. The law firm was established in 1985. The North Miami office is located at 11645 Biscayne Blvd. with telephone number (305) 891-4055. The South Dade office is located at 10700 Caribbean Blvd. with telephone number (786) 253-0953. Chapter 7 personal bankruptcy is generally used to discharge your dischargeable debt including credit cards, medical bills, and unsecured loans. Chapter 13 bankruptcy is generally used to reorganize your financial affairs while under the protection of the Bankruptcy Court. Chapter 13 bankruptcy is often used to stop a mortgage foreclosure and to catch the payments up-to-date.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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The Bankruptcy Court of the Southern District of Florida recently ruled that a Chapter 7 debtor, who was required to use the Rhode Island exemptions due to his previous domicile in Rhode Island, was allowed to exempt his Florida home under the Rhode Island homestead exemptions. In re Jevne, 2008 WL 906533 (Bankr.S.D.Fla. April 2, 2008)(Hyman, J.).
In this case, pursuant to section 522(b)(3)(A), the debtor was required to use the Rhode Island exemptions as he was not domiciled in Florida for the entire 730 day period prior to his bankruptcy filing and he was domiciled in Rhode Island for the great part of the 180 day period prior to the 730 day period. The court characterized the provisions of section 522(b)(3)(A) as a "choice of law" provision. The court stated that Rhode Island's statutory homestead exemption would apply if it applied extraterritorially. The court noted that while some states homestead statutes' plain language limit their application to property within the state, homestead statutes in other states are "silent" on the propriety of their extraterritorial application. The court concluded that if the language of a state's homestead statute restricts its application to property located within the state, the statute cannot be given extraterritorial effect, but if the homestead statute is silent as to its extraterritorial effect, the court will review that state's case law precedent to determine if the homestead statute can be applied to property outside of the state. See eg In re Dentrell, 403 F.3d 611 (8th Cir. 2005), In re Arrol, 170 F.3d 934 (9th Cir.1999). The court found that the Rhode Island homestead statute was silent as to its extraterritorial effect and that there was an absence of case law as to the issue of its extraterritorial application. Therefore, the court allowed the debtor to apply the $300,000 Rhode Island homestead exemption statute to exempt his Florida residence.
It should be noted that there is a distinction in the court's ruling from that of the Eight Circuit in Dentrell. Here the court held that when the prior state's homestead statute is silent, it would look to the state's case law, including apparently its principles of comity and choice of law, as to whether it may apply extraterritorially. It that sense, there would be a second choice of law consideration after the application of section 522(b)(3)(A)'s initial "choice of law" provision. In contrast, the Dentrell court held that the bankruptcy code incorporates applicable state law exemptions without incorporating the state's comity and choice of law principles.
In Dentrell, the trustee argued that while the prior state's statute was silent on the issue of extraterritoriality, it should not be applied to real property in the debtor's new state, as states traditionally do not give extraterritorial effect to statutes relating to the ownership of real property. The Dentrell court noted that this general rule is based on state interpretation of state law and that it may not apply with equal force in the context of a federal statute as "[t]raditional concerns respecting the dignity and sovereignty of other states and limiting jurisdiction to the state borders are simply inconsistent with the national effect and supremacy of federal law. In re Drentell, 403 F.3d 611, fn.1. The Dentrell court rejected the trustee's argument which was not based on the state's statutory language but rather on the state's comity and choice of law principles. The court noted that to adopt the trustee's argument, would require it to construe the phrase "the law that is applicable" as used in section 522(b)(2)(A) (now 522(b)(3)(A)) to refer to the whole of the state's law. Furthermoe, the court further noted that if the prior state's principles of comity and conflicts of law were applied, the bankruptcy court would have to consider whether the prior state would apply the new state's homestead exemption law to real property in the new state and in effect reverse the choice of law provision of 522(b)(2)(A).
The court was not persuaded that the phrase "the law that is applicable" of 522(b)(2)(A) invoked state choice of law rules. The court stated that "[r]eferences to state exemption statutes do not invoke the entire law of the state" and that "[c]ongress used state-defined exemptions as part of a federal bankruptcy scheme, while limiting the application of state policies that impair those exemptions." Owen v. Owen, 500 U.S. 305 (1991)(finding no inconsistency in the policy of permitting state-defined exemptions while disfavoring waiver of exemptions and impingement of liens on exemptions), Butner v. United States, 440 U.S. 48 (1979)(acknowledging that property interests normally governed by state law could be analyzed differently if some federal interest requires a different result). The Dentrell court held that the homestead statute of the prior state of domicile would be applied without regard to its choice of law rules and that its choice of law jurisprudence is irrelevant. See Collier on Bankruptcy, 15th Edition Revised, para 522.06 (2008). In short, there is a distinction between the holdings in Jevne and Drentell, as the court in Jevne would look to the state's principles of comity and conflicts of law as to whether a state's homestead statute that is silent on the issue would apply extraterritorially, while the court in Drentell would not apply the state's principles of comity and conflicts of law.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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In the recent case of Everhome Mtge. Co. v. Rowland, 2008-Ohio-1282 (10th Appellate District, March 20, 2008)(Klatt, J.), the Ohio Court of Appeals reversed the trial court order granting the plaintiff's motion for summary judgment for foreclosure and found that there existed a genuine issue of fact whether the plaintiff is the holder of the note and mortgage.
The court held that under Ohio rules of civil procedure, [e]very action shall be prosecuted in the name of the real party in interest.". Civ.R.17(A). The real party in interest in a foreclosure action is the current holder of the note and mortgage. Chase Manhattan Mtge. Corp. v. Smith, Hamilton App. No. C-061069, 2007-Ohio-5874, at para. 18. A party that fails to establish itself as the current holder is not entitled to judgment as a matter of law. First Union Natl. Bank v. Hufford (2001), 146 Ohio App. 3d 673, 677, 679-680.
The court found that the note and mortgage in this case did not identify the plaintiff as the lender, but set forth a different entity as lender. To prove its status as the current holder of the note and mortgage, the plaintiff relied on the affidavit testimony of an officer which merely stated that the attached documents were true copies of the note and mortgage. The court concluded that this affidavit was insufficient to establish that the plaintiff was the current holder of the note as it failed to specify how or when it became the holder of the note and mortgage. The court stated that without evidence demonstrating how it received an interest in the note and mortgage, the plaintiff cannot establish itself as the holder. According, the court found that there was a genuine issue of material fact regarding whether the plaintiff was the real party in interest and reversed the trial court's summary judgment.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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In December, 2007, Congress passed the "Mortgage Forgiveness Debt Relief Act of 2007" to alleviate tax consequence for some homeowners in foreclosure. The new Act excludes from gross income certain cancelled discharged "qualified principal residence indebtedness."
Existing law provides that discharged debt, whether after a foreclosure or short sale, is generally taxable income realized in the year the debt was forgiven, unless an exception applies. Generally only reductions in principal and not forgiveness of interest results in discharge of indebtedness income ("DOI"). Usually a lender is required to issue a Form 1099-C to report the DOI to the IRS. Taxpayers are required to disclose DOI to the IRS whether the lender issues a 1099-C or not. Taxpayers may be able to exclude the DOI from income if an exceptions to DOI applies.
Two existing exceptions to DOI are the insolvency and bankruptcy exceptions. 26 U.S.C. section 108(d). If the borrower is insolvent, DOI is not taxable. If the debt is discharged in bankruptcy, DOI is also not taxable. Another exception is the "purchase price infirmity doctrine". This allows DOI to be excluded from income where the lender agrees to write down the purchase money debt to the true value of the collateral as the purchase price was inflated in the original transaction due to fraud or misrepresentation. Another exception from DOI is when the liability was contested. Pursuant to Zarin v. Comm'r, 916 F.2d 110 (3d Cir.1990), DOI is not income where there is a legitimate basis for the borrower to claim that the debt was never owed or collectible because illegal.
The new Act adds to the existing exceptions from DOI a category of "qualified principal residence indebtedness." Up to $2 million of indebtedness may be excluded if the reason for the discharge is either a decline in the residence's value or the taxpayer's financial condition. It should be noted that debt excluded by the Act reduces the taxpayer's basis and a "short sale" could result in a taxable "gain" which may be taxable as a capital gains.
In order for this new exception to apply, the debt must be "qualified" which includes only acquisition and not home equity indebtedness. Acquisition indebtedness includes funds borrowed to buy, construct, or improve a home. Debt consolidation loans or cash out loans are generally not acquisition indebtedness. The Act only applies to debt discharged between January 1, 2007 and December 31, 2009. Pub.L.No. 110-142 Section 2(d). If acquisition debt is refinance, the refinanced principal amount retains its status as acquisition indebtedness. The excess of the total refinanced loan amount over the refinanced acquisition indebtedness is treated as home equity indebtedness and is not eligible for exclusion from income. Acquisition indebtedness included loans to "substantially improve" the principal residence.
This new exclusion only applies if the debt was discharged due to the borrower's financial condition or a decline in the home's value. A discharged based on the lender's acknowledgment of its wrongdoing or even rescission is not eligible for the qualified principal residence exclusion. Documentationj in any litigation or settlement that one of the required grounds is the basis for the discharge of the debt would be helpful.
The homeowner must apparently elect to take either the qualified principal residental exception or the insolvency exception. The insolvency exception, if elected, is "in lieu of" the qualified principal residence excetion.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983
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Last month, Senator Durbin (D, IL) introduced the Foreclosure Prevention Act in the Senate (S. 2636). This proposed legislation would help people save their homes from foreclosure by giving Bankruptcy Judges the power to modify the terms of a mortgage loan in a chapter 13 bankruptcy.
Although it is reported that Republicans blocked action on the bill last month, new efforts are underway to try to reach an agreement. The bill is opposed by the financial service industry and the Bush Administration. It is also not embraced by all Democrats.Jordan E. Bublick, Miami, Florida, Attorney at Law, Practice Limited to Bankruptcy Law, Member of the Florida Bar since 1983