RULLCA – New California LLC Law Coming in 2014

On January 1, 2014, the California Revised Uniform Limited Liability Company Act (“RULLCA”) goes into effect, and will automatically apply to all California LLCs.  RULLCA will replace the Beverly-Killea Limited Liability Company Act, the current California LLC law.    

Generally, it will be unnecessary to reference Beverly-Killea when once this year ends.  Beverly-Killea will, however, remain relevant when considering acts or transactions by an LLC or its members or managers before January 1, 2014.  In addition, contracts dated prior to January 1, 2014 will also be governed under Beverly-Killea.  

Although RULLCA will not require existing LLCs to file any new documents with the Secretary of State or necessarily amend their operating agreements, it may be prudent to seek the advice of an attorney.  Particularly, older operating agreements that specifically reference Beverly-Killea should be amended to instead cite RULLCA.

While RULLCA is not a significant departure from Beverly-Killea, it has some notable differences.  For example, if there is a conflict between a provision in the operating agreement and a provision in the articles of organization, under RULLCA the operating agreement will prevail, except for third parties who reasonably rely on the articles of organization.  Under Beverly-Killea, conflicts were resolved in favor of the LLC’s articles of organization. 

Another change under RULLCA is that an LLC member will be bound to the operating agreement even if that member does not sign it.  

These are simply a few examples of what to expect.  For the most part, RULLCA represents an improvement to the default rules and was intended to align California closer to the LLC laws of other states.  It is expected the Act will be “tweaked” further before its January 1, 2014 effective date.  Significant changes will be noted in future blog posts.  

If you have an existing LLC and operating agreement, I would be pleased to review these matters with you to determine what changes, if any, are appropriate to ensure that your company will be compliant with the new Act.    

SB 30 Passes Major Milestone

Senate Bill 30, the bill to reinstate the California state tax exemption for cancelled or forgiven mortgage debt of qualified homeowners, passed a major hurdle on May 23, 2012, when the legislation was passed out of the Senate Appropriations Committee by a 7-0 vote.

While the bill still requires a vote by the full senate, as well as Governor Brown’s signature, the likelihood of ultimate passage of the bill seems much higher following the unanimous approval by this very key committee.

As background, the previous tax exemption expired on December 31, 2012, and has remained mired in the legislative weeds while the governor and legislature battle over other state funding priorities.  The result has been significant uncertainty in the “distressed property” market, with real estate professionals and “underwater” homeowners lacking clarity on whether there would be state income tax consequences following a short sale, foreclosure, deed in lieu of foreclosure, or other mortgage debt cancellation event.

(The federal tax exemption for qualified homeowners was renewed in February 2013, and remains in place through the end of this year.)

If passed, the bill will amend Section 17144.5 of the California Revenue and Taxation Code, to provide for a one-year extension of the state tax exemption for certain cancelled mortgage debt.  It is not expected the exemption will be renewed again, so that any homeowner seeking its protection must conclude her/his transaction by December 31, 2013.  Since a short sale can take several months to close, it is recommended that individuals considering this option immediately consult with a qualified real estate professional, as well as seeking advice from experienced attorney and tax adviser.

Still No News on SB 30 (StateTax Exemption for Forgiven Mortgage Debt)

As scheduled, the state legislature’s Appropriations Committee held a hearing earlier this month to determine the fate of Senate Bill 30.  As a reminder, this is the bill that, if passed, would restore the state tax exemption for the “shadow income” homeowners are imputed to have received if their home is foreclosed or sold in a short sale.  That exemption expired on December 31, 2012.

Unfortunately, the committee chose to “table” consideration of the bill to a later date.  Specifically, the bill was placed in the AC’s  “Suspense File”, to which the committee sends any bill with an annual cost of more than $150,000.  Suspense File bills are then considered at one hearing after the state budget has been prepared and the committee has a better sense of available revenue. No testimony is presented – either by the bill’s author or any witness – at the Suspense File hearing.

At present, we have no definitive date on which the Suspense Bill hearing will occur.  And the current high volume wrangling between the governor and the legislature over education funding makes it unlikely a final vote on SB 30 will occur pending resolution of these other political “hot potato” budget issues.  Stay tuned.

California Short Sale Tax Exemption Hearing Scheduled

California Senate Bill 30, which will reinstate the state tax exemption applicable to cancellation of qualified mortgage debt, is scheduled for a hearing before the Committee on Appropriations on April 8, 2013.

The bill was previously amended by the Committee on Government & Finance, following which it was approved by a 6-0 vote, subject to approval by the Appropriations Committee.

If the bills successfully emerges from the Appropriations Committee, it will be scheduled for a vote by the full legislature and, if passed, sent to Governor Brown for signature.

As amended, the bill will provide for reinstatement of the state tax exemption retroactive to January 1, 2013 and through December 31, 2013, mirroring the expiration of the federal 982 homeowners’ exemption.   Stay tuned….

Important Update on Status of California Short Sale Tax Issue

I wrote last week that the federal tax exemption for mortgage debt forgiveness had been extended for one year as part of the “fiscal cliff” settlement between Congress and the White House.

  • California’s Homeowners Exemption has Expired

At that time, I also wrote that the California tax exemption expired on December 31, 2012, without having been extended by the state legislature.  Consequently, mortgage debt forgiveness is currently subject to California state income tax.

  • Senate Bill Introduced to Reinstate the California Exemption

To remedy this inconsistency between federal and state tax law, the California Association of Realtors is sponsoring Senate Bill 30 (Calderon, D-Montebello).  SB 30 will conform state law to the federal law passed last week.  Upon passage of SB 30, the measure as currently drafted will be effective retroactive to Jan. 1, 2013.

  • Contact Your Local State Representative

If you believe the state tax exemption should be reinstated, contact your local state senator and ask that he/she support SB 30.

I will report further as the bill moves its way through the legislative process.

 

URGENT: Homeowners Tax Exemption Extended Through 2013

The 2007 Mortgage Debt Relief Act, which was scheduled to expire at midnight on December 31, 2012, has been extended for one year as a result of the “fiscal cliff” deal struck between Congress and the president.

The Senate included the extension as a part of the bill that passed at 2:00 a.m. on Tuesday morning.  After House Republicans failed to pass a separate bill modifying the Senate plan, that plan was presented for a full house vote late last night and passed 257-167.  President Obama has stated he will sign the bill.

EXTENDS TAX FORGIVENESS FOR MANY HOMEOWNERS WHO COMPLETE A SHORT SALE, FORECLOSURE, “DEED IN LIEU”  OR LOAN MODIFICATION IN 2013.

This is very important news for homeowners whose short sales and “deeds in lieu of foreclosure” had not been concluded by December 31st, and who were facing a substantial income tax bill if the exemption had expired and not been renewed.  It also will benefit many homeowners whose properties are foreclosed in 2013, as well as individuals who obtain a “principle reduction” loan modification on their home mortgages.

EXEMPTION DOES NOT COVER ALL FORGIVEN MORTGAGE DEBT

As I have previously explained, the tax exemption does not apply to all forgiven mortgage debt.  Specifically, the debt must have been on a primary home, and the debt must have been used to either buy the property, to pay off purchase debt, or to repair/renovate the home.  It does not apply to debt on second homes or income property, or on “cash out” refi debt.

STATUS OF CALIFORNIA’S SEPARATE TAX EXEMPTION NOT YET CLEAR

Keep in mind that the separate California tax exemption for mortgage debt relief also was scheduled to expire on December 31, 2012.  Whether that state exemption will be extended as a result of the federal extension is not yet known.  I will report further once that information becomes available.

I recommend you immediately contact your local representative if you feel the California tax exemption should also be extended.

CONSULT WITH A QUALIFIED ATTORNEY OR TAX ADVISER NOW TO DETERMINE IF YOU QUALIFY

For “underwater” homeowners that have been “sitting on the fence”, now is a good time to speak with a qualified real estate attorney or tax adviser to determine whether and to what extent you qualify for the extended tax exemption.  Keep in mind that it can take many months for a short sale, loan modification, “deed in lieu” or foreclosure to be completed.  For that reason, it’s important to get the process started as soon as possible.  That way you can implement your best strategy without having to worry about losing the tax exemption at the end of 2013.

 

SB 458/931 Not Impacted by Debt Forgiveness Relief Act Expiration

No New News of Possible Extension of Mortgage Debt Relief Act

I continue to receive daily inquiries from homeowners and real estate professionals regarding the pending December 31st expiration of the Mortgage Debt Relief Act.  Unfortunately, the matter remains mired in the highly politicized negotiations over the “fiscal cliff.”  While I remain hopeful that the necessary parties will set aside their differences for the benefit of distressed homeowners, that hope is tempered by skepticism based on the lack of progress in the negotiations.

Meanwhile, I urge all affected individuals to contact their congressional and senate representatives to let them know where you stand.  And keep your fingers (and toes) crossed.

My purpose is writing this blog is to address a separate but related issue about which I’ve also received numerous questions.  Specifically, are California’s SB 458/931 threatened by the potential expiration of the Act?  The short answer is “no.”

Don’t Confuse California’s Short Sale “Anti-Deficiency” Protections with the Taxability of Forgiven Debt

California Senate Bills 458 and 931 were enacted in 2011 and are now found in Section 580e of the Code of Civil Procedure.  These laws say that a lender who agrees to a short sale is barred from collecting any portion of the mortgage debt not paid from the proceeds of sale.  In other words, the “deficiency” is deemed “forgiven” as a matter of law; thus the term “anti-deficiency” protection.

Before Section 580e, lenders frequently approved short sales only on the condition that the seller/borrower agreed to repay some portion of the loan deficiency.  This is no longer allowed.  More importantly, there is no “expiration date” to this California statute.  It will remain in effect unless and until repealed by the legislature with the consent of the governor.  That is extremely unlikely.

In summary, no matter what happens with the Mortgage Debt Relief Act, mortgage holders whose lenders approve a short sale of their California property will remain protected by the state’s “anti-deficiency” statutes; they will not have to repay any portion of the unpaid, forgiven loan balance.

Impact of Expiration of Act on California Short Sales

In contrast, expiration of the Mortgage Debt Relief Act will remove many of the protections that qualified homeowners have had since 2007 for the tax consequences of forgiven mortgage debt.  In other words, the IRS will tax as income any portion of the home loan not repaid to the lenders from the proceeds of the short sale.  (As stated in earlier articles, there are other possible tax exemptions applicable to this “income”; however, far fewer property owners will qualify for these other protections.)

Expiration of the federal Act will trigger expiration of California’s related tax protection.  That is, the law passed in California to protect homeowners from the state income tax liability for forgiven debt also expires on December 31, 2012.

There is no guarantee that an extension of the federal exemption will automatically result in an extension of the California exemption.  For that reason, it is also important to contact your representatives in Sacramento to urge extending the state tax protection.

If you are uncertain regarding the impact of these matters on your situation, please contact qualified legal and tax professionals without delay.


 

“Simon Rule” Gutted by New Court Decision

The so-called “Simon Rule”, among the most potent weapons available to distressed homeowners in negotiating short sales, and protecting themselves from financial liability following foreclosure, has been significantly weakened as a result of a new California court of appeals decision.  That decision, Cadlerock Joint Venture, LP v. Lobel (2012) 203 Cal.App.4th 1531, will change the landscape to the detriment of many struggling California mortgage holders.

How Does This Impact Homeowners Considering a Short-Sale?

Cadlerock now requires a court to look at who owns the loans at the time of the foreclosure by the senior lienor.  If the senior lienor has assigned/sold its junior lien to a third party prior to the foreclosure, that third party will now be able to sue the homeowner for the full amount of the junior loan after the foreclosure.  To summarize, following Cadlerock, in most situations the homeowner will lose the home and also have to repay the balance of the non-purchase money second loan.  (The court left a small amount of “wiggle room” for cases where the senior lienor assigns/sells its junior lien after the foreclosure.  There, Simon will still apply.)

Simon Rule Background

As discussed in previous articles, for the last twenty years many Californians with non-purchase money second loans have been able to protect themselves from claims brought by certain “junior” lenders after a foreclosure by the “senior” lender.  This protection originated in a landmark case called Simon v. Bank of America (1992) 4 Cal.App.4th 1537.

The Simon decision created an exception to the old rule that applies where a homeowner has two separate loans on a single property, and where the first mortgage holder (aka the “senior lienor”) forecloses on the property.  Before Simon, the second loan (aka the “junior lienor”) could collect the balance still owing on that loan after the senior foreclosed (and so long as the second loan was not a “purchase money” loan; i.e., part of the loan “package” used to buy the house).  (“Purchase money” second loans were, and still are, barred from collection under a separate rule not discussed here.)

What Simon said was that where the first and second loans were issued by the same bank (in that case, Bank of America), the bank could not collect on its second loan after foreclosing on its first loan; thus, the “Simon Rule”.  An equally important part of the rule was that a bank could not avoid this restriction by “assigning”, or selling, its second loan to another bank or investor.  In other words, courts would look to who owned the loans when they were issued.  If the same bank issued the two loans, the “Simon Rule” would apply.

In recent years, Simon became an invaluable tool in negotiating short sales involving non-purchase money second loans.  (See my January 2012 blog post, Playing the Simon Card in Short Sale Negotiations.Cadlerock now renders that tool virtually useless.

All homeowners considering short sales should consult with competent legal counsel to determine the impact of Cadlerock on their situation.  Failure to do so may result in enormous financial consequences and long-term hardship.

Short Sale Tax Exemption Update

I recently attended a networking event of local Bay Area realtors, and was shocked to hear a young realtor say she had heard that the short sale homeowners tax exemption, scheduled to expire on December 31, 2012, had been extended.  I quickly informed her that her information was incorrect, and that the exemption remains on track to expire at the end of the year.  My purpose in this blog is to provide a status update regarding the homeowners exemption, and to clarify the availability of another potential tax exemption for homeowners unable to complete their short sale in time.

As a reminder, homeowners whose mortgage debt is forgiven, reduced or cancelled in a short sale, foreclosure or loan modification will receive a 1099 from their lender in the amount of the unpaid debt.  And unless they qualify for a tax exemption, they will have to pay income tax on the 1099 amount.  Since 2007, many homeowners have been able to avoid the tax by applying for the IRS Form 982 homeowners exemption.  (The exemption does not apply to all home mortgage debt; there are limitations that can be explained by a knowledegable tax professional.)

First, it is correct that President Obama has proposed that Congress extend the homeowners tax exemption, also known as the Mortgage Forgiveness Debt Relief Act, through 2013.  But it is only a proposal.  The Senate Finance Committee has also approved a bill to extend the Act; however, that’s as far as it’s gotten.  And the highly partisan congressional and presidential battles makes it virtually certain that nothing will happen until after the November 6th national election.

The hope is that the “lame duck” congress will then extend the exemption.  Knowledgeable prognosticators currently place the odds at 60/40 in favor of the extension; however, that is only speculation.  There is a significant risk that the looming “financial cliff” and public pressure to reduce the deficit may torpedo the exemption.  Congressional estimates are that a one-year extension of the Act will reduce government revenues by as much as $1.3 billion.

Homeowners facing potential tax liability from mortgage debt cancellation — resulting either from a foreclosure, short sale or loan modification — are urged to determine if they qualify for the “insolvency” exemption.  Unlike the homeowners exemption, the insolvency exemption does not expire this year.  And it is available for more types of mortgage debt that the homeowners exemption.

Briefly, if the fair market value  of all your assets, including your retirement accounts, is less than your total debt, you are “insolvent” for tax purposes.  Depending on the extent of your insolvency,  you may be able to reduce your 1099 mortgage debt tax liability.  For example, if you have $100,000 in 1099 mortgage debt income, and your debts exceed your assets by $50,000, your taxable income is reduced by $50,000.  (Again, these calculations should be done by a qualified tax professional.)

Please contact me if you need help determining your individual situation.  It is critical you make no decision unless and until you know the consequences.  An incorrect choice may potentially place you in even worse condition, something few homeowners can afford.