The following is written by Paragon Title’s Dick Fritz. He is very good at what he does and he sent this out to me today so I could share it with my agents. I pass it along to you…

We have just been informed by the Montgomery County Transfer Office that they have decided to change their method of calculating transfer and recordation taxes on certain short sale transactions. This does not apply to all short sale transactions — only to those transactions in which the seller is lucky enough to get their lender to agree to waive the deficiency and let them walk away from the property without owing anything. For those situations where the lender does not waive the deficiency and is going to pursue the seller after settlement for the balance of money owed, it is business as usual and the transfer and recordation taxes will be calculated on the sales price in the contract. What is the same and what is different is summarized below:

SCENARIO 1: Short Sale — Seller’s lender is NOT waiving the deficiency and will pursue Seller after settlement for balance owed on the loan

RESULT 1: NO CHANGE — Transfer and Recordation Taxes are calculated on the contract sales price

SCENARIO 2: Short Sale — Seller’s Lender IS waiving the deficiency and Seller will owe nothing after settlement — loan is marked as paid for less than owed

RESULT 2: NEW CALCULATION — Transfer and Recordation Taxes are calculated on the contract sales price PLUS the difference between the contract sales price and the balance the seller owes on his loan

Consider the following examples:

EXAMPLE 1:

Contract Sales Price: $200,000.00

Balance owed on Loan: $300,000.00 ($100,000.00 deficiency)

Seller’s Lender Action: Lender will pursue the Seller for the $100,000.00 owed after settlement

Transfer Taxes: Calculated on Contract Sales Price of $200,000.00; the $100,000.00 deficiency is not taxable because it is not waived

EXAMPLE 2:

Contract Sales Price: $200,000.00

Balance owed on Loan: $300,000.00 ($100,000.00 deficiency)

Seller’s Lender Action: Lender will waive the deficiency; Seller owes nothing after settlement

Transfer Taxes: Calculated on Contract Sales Price of $200,000.00 PLUS deficiency of $100,000.00 = Transfer Taxes due on $300,000.00

EXAMPLE 3:

Contract Sales Price: $200,000.00

Balance owed on Loan: $225,000.00 on first loan ($25,000.00 deficiency) and $75,000.00 on second loan ($75,000.00 deficiency)

Seller’s Lender Action: First Lender will waive deficiency on first loan; Second Lender will pursue Seller for the $75,000.00 on second loan

Transfer Taxes: Calculated on Contract Sales Price of $200,000.00 PLUS the $25,000.00 waived on First Loan = Transfer Taxes due on $225,000.00; the $75,000.00 deficiency on the Second Loan is not taxable because the Second Lender will go after the Seller for the $75,000.00 after settlement.

Obviously this has great significance when putting together sales contracts and negotiating short sales. We make the following recommendations:

1. From the Buyer’s and Selling Agent’s Perspective — Negotiating the Sales Contract

Clearly, the Buyer is entering the transaction expecting to pay transfer taxes on the sales price stated in the sales contract. The Buyer is not expecting the amount of transfer taxes that the Buyer is going to be paying to be dependent on something the Buyer has no control over — whether or not the Seller is successful in negotiating with the short sale lender to waive any deficiency due under the loan. However, the language in the Sales Contract does not deal with this situation. It has the Buyer and Seller negotiating on how to pay whatever transfer taxes are charged by the government in order to record the Deed, but does NOT limit it to only those transfer taxes charged on the contract sales price. Therefore, if the transaction is a short sale and the Buyer wishes to limit his liability to only those transfer taxes that are calculated on the Contract Sales Price, we suggest the following language be added to the Sales Contract:

Buyer shall be obligated to pay Buyer’s portion of the transfer and recordation taxes for recording the Deed based on the Contract Sales Price. Any transfer and recordation taxes charged by the government to record the Deed on an amount in excess of the Contract Sales Price shall be paid by Seller.

2. From the Buyer and Selling Agent’s Perspective — Applying for a New Loan

Under the new RESPA Rule, the Buyer’s Lender must provide the Buyer with a Good Faith Estimate (GFE). Under the new RESPA Rule, there are certain items on the GFE that fall into the category that they cannot be higher at settlement than listed on the GFE. Amongst the items in this category are TRANSFER TAXES. So, if the Buyer’s Lender gives them a GFE calculating the transfer taxes based upon the contract sales price and at settlement they are higher (based upon the contract sales price PLUS the deficiency), the lender has two choices: (A) pay the difference to the buyer (they certainly aren’t going to want to do that); or (B) state that there are changed circumstances (in this case the Seller’s short sale lender waiving the deficiency — which would be correct), delaying settlement, and issuing a new GFE showing the higher transfer taxes.

If, under the provisions of the sales contract, the Buyer might end up paying any portion of the transfer taxes calculated on a waived deficiency, then alert the Lender to this possibility in advance so that transfer taxes can be listed on the GFE at the higher number. Then, if the transfer taxes are lower at settlement, settlement can still proceed without a delay (it is always permissible for the Buyer’s costs to go down without having to issue a new GFE and delay settlement).

3. From the Seller’s and Listing Agent’s Perspective — Negotiating the Sales Contract and Getting the Short Sale Approved

Nothing spoils a short sale settlement faster than the short sale lender approving one set of numbers (in this case transfer taxes based upon the Contract Sales Price) and those numbers changing at the time of settlement (adding transfer taxes based upon the deficiency). This can quickly turn an approved short sale into an unapproved short sale. Bad for the seller, bad for the buyer, and now no sales commissions after all that work. Or even worse — someone else has to come up with the extra money. If the seller can’t, and the buyer won’t, then we all know where all eyes turn and this is also bad. How to protect against this:

A. MAKE SURE THE SELLING AGENT UNDERSTANDS TRANSFER TAXES MIGHT BE CALCULATED ON A NUMBER HIGHER THAN THE SALES PRICE AND NEGOTIATE IN THE SALES CONTRACT HOW THE EXTRA TAXES ARE TO BE PAID. Don’t just assume they know. If you do, you are opening yourself up to an argument later on as to who has to pay the extra money.

B. When having settlement statements prepared to send to the short sale lender for approval, have the transfer taxes calculated on the highest possible number (the principal balance the seller owes on the loan(s) rather than the contract sales price), and have the transfer taxes divided up between the Buyer and Seller on the HUD1 as you negotiated them in 2.A. above. If the short sale lender approves a HUD1 with higher transfer taxes and the lender getting less money, and it turns out at settlement that the transfer taxes are lower and the short sale lender gets more money, the lender will approve the HUD1 and it can settle.

C. IF THE LENDER IS GOING TO PURSUE THE SELLER FOR THE DEFICIENCY AFTER SETTLEMENT, MAKE SURE THE SHORT SALE APPROVAL LETTER SAYS THE LENDER IS GOING TO DO THIS. Montgomery County has indicated that they are going to PRESUME that the deficiency is waived (and is thus taxable) UNLESS written evidence is presented to them that the deficiency is not waived. Thus, if the short sale lender is going to go after the Seller for the balance of the money after settlement, make sure the short sale approval letter says they are going to do this. Otherwise, Montgomery County will tax the extra amount.

This is just a short (or maybe not so short) discussion of this issue. We will also address this at various sales meetings, but since Montgomery County made their official pronouncement today in the form of a bulletin, we thought it important that all of you be notified immediately.