'Deed in Lieu of Foreclosure' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A deed in lieu of foreclosure represents an alternative option to a standard foreclosure on a house. In this deed in lieu arrangement, the owner of the property decides to hand over the property in question to the lender on a completely voluntary basis. In exchange for agreeing to this, the lender cancels out the mortgage loan. The deed to the house becomes transferred from the owner to the lender. As part of this conciliatory arrangement, the mortgage lender guarantees that it will not start the foreclosure process on the owner. If there are any foreclosure actions that have already begun, the lender will also terminate these. It is up to the lender to decide if they will forgive any extra balance that the sale of the home does not cover.
There are some tax issues that can arise with a deed in lieu of foreclosure deal. One potential downside to this type of debt forgiveness involves the consequences of it with the IRS. Federal law in the United States requires creditors to file 1099C forms for tax purposes when they choose to forgive any loan balance that amounts to more than $600. This debt forgiveness is then considered to be income and it becomes a tax liability for the home owner.
Fortunately for many home owners during the financial crisis, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007. This delivered tax relief on a number of loans that banks forgave in the years starting from 2007 till the end of 2013.
The main issue and advantage that a deed in lieu of foreclosure offers centers around this excess balance debt forgiveness. Anyone who enters into such a voluntary agreement should carefully review the contract to learn how the deficiency balance topic will be addressed. Sometimes the documents are not clear on this point.
In this case, the homeowner should take the deed in lieu document to a lawyer who specializes in property law. It is not inexpensive to have a lawyer review such a contract document. The money it can save the home owner in the future for signing a contract he or she does not understand and may suffer significantly from will make the fees seem reasonable by comparison.
There are a number of requirements in order for a deed in lieu of foreclosure to be accepted. First the house would have to be on the seller market for a minimum number of days. Ninety days is usual. There also may not be any liens on the house. The property typically could not be in the process of foreclosure already. Finally, the deed in lieu offer has to be voluntary on the part of the home owner.
Another option that can be pursued in place of this deed in lieu of foreclosure is a short sale. Short sales have the same requirements as do the deed in lieu arrangements with several additional stipulations. The home seller must be suffering from financial hardship. The home itself has to be offered at a reasonable price.
In an alternative short sale, the mortgage lender will consent to receiving a lesser amount from the sale than the remaining mortgage balance that the owner still owes. It is up to the bank and the contract if any additional balance which exists will be forgiven or not. The same tax issues apply if the lender agrees to forgive more than $600.