The Washington State Department of Revenue (DOR) seems to think so. Background: At an Escrow Association of Washington (EAW) meeting on Nov 13, 2008, Mel Kirpes and Steve Bren from WA DOR spoke at a regional dinner meeting where it was announced that when there is a short sale, the DOR considers the debt forgiven as additional consideration above the contracted sales price between the parties and that the DOR will be pursuing the home seller for payment of the excise tax. (Reference is a EAW letter dated Nov 25, 2008 from EAW Director Cindi L. Holstrom)
Naturally this had a chilling effect amongst escrow officers. The DOR responded on Dec 12, 2008 in a letter from Gilbert Brewer, Assnt Director of the DOR:
RCW 82.45 imposes an excise tax on the sale of real estate unless specifically exempt from statute. “The measure of the tax is based on the total selling price of the property conveyed. The incidence of the tax is usually on the seller. However, if the tax is not paid in full, the tax (together with any interest and penalties) becomes a lien on the real property. This is mandated by RCW 82.45.030 …which defines “selling price” as the “true and fair value of the property conveyed.” If a property has been conveyed in an arm’s length transaction between unrelated persons for a valuable consideration, a rebuttable presumption exists that the selling price is equal to the total consideration paid or contracted to be paid to the transferor, or to another for the transferor’s benefit….”total consideration paid or contracted” to be paid as including “money or anything of value, paid or delivered or contracted to be paid or delivered in return for the sale, and shall include the amount of any lien, mortgage, contrat, indebtedness, or other incumbrance, either given to secure the purchase price, or any part thereof, or remaining unpaid on such property at the time of the sale.”
Since there is an exemption from real estate excise tax in the event of foreclosure or a deed in lieu of foreclosure (see WAC 458-61A-208) this DOR opinion may unfortunately motivate homeowners to consider foreclosure a more viable option. Perhaps the home seller’s Realtor can negotiate with the lender to pay for the additional excise tax lien as well. However, then that extra amount paid by the lender may also be subject to excise tax.
The Seattle King Co Assoc of Realtors and Washington Realtors believes DOR’s position is incorrect and problematic. On Jan 8, 2009, The Northwest Multiple Listing Association posted a notice to their real estate agent members as follows:
“RCW 18.86 requires agents to advise their clients to seek expert advice on matters relating to the transaction that are beyond the agent’s expertise. This duty exists in every transaction but is particularly important in short sale transactions where unique legal and tax issues exist.”
We’ve been saying the same on RCG for many years now. Short sales are way more complex for real estate agents than the average transaction and homeowners are best served when they have retained their own legal counsel to help them understand the lender paperwork as well as this current DOR trainwreck. You may be thinking, “homeowners in financial distress can’t afford an attorney.” However, some attorneys offer low cost options for homeowners facing foreclosure.
UPDATE
January 13, 2009
Department of Revenue: “After receiving extensive input from interested stakeholders and industry representatives about the nature of these transactions, we have carefully reconsidered how real estate excise tax statutes apply to these unique transactions [short sales]….we now see that these short sales are distinguishable from other transactions involving the forgiveness of debt because the seller negotiates separately with the lender for any debt reduction/forgiveness, apart from the actual purchase and sale of the property. As a result, the loan forgiveness is not “paid or delivered in return for the sale” of the property, as required by RCW 82.45.030.” Margaret J. Partlow, Senior Policy Counsel, Dept of Revenue.
(Hat tip Rhonda Porter and Kary Krismer.)
Translation: We are not going to require sellers to pay excise tax on the debt forgiveness with a short sale.
40 representatives from escrow, title, real estate, attorney, and short sale faciliator companies showed up in Olympia to help educate the Dept of Revenue. Thank you, Escrow Association of Washington, for bringing this to our attention and taking on the state head to head.
There are a lot of mechanical and legal problems associated with DOR’s request to do this. But, the larger issue lost in all this is from a short sale seller: I’m not getting any money, thus, the impact on my bottom line is irrelevant, so why the fuss?
The Dept. of Revenue, re-defining perhaps what is construed as “consideration,” is going after an additional 1.78% of what……50K, 100K that the borrower received in a loan above the sales price? Do the math. Good for DOR, meaningless for those involved in a short sale. Good for DOR to replace lost revenue because of the market correction, but the impact on real estate sales activity is highly debatable.
The debate over whether or not a seller should let a property foreclose vs. short sale is a completely different issue centered on personal, tax and other reasons. If people find it better to just walk away, which some are doing, then certainly short sales don’t take place, commissions are not paid to sales agents, escrow/title and others won’t get paid.
The statute ends: “and shall include the amount of any lien, mortgage, contrat, indebtedness, or other incumbrance, either given to secure the purchase price, or any part thereof, or remaining unpaid on such property at the time of the sale.”
I’d emphasis the “on such property” portion of the language. What it’s intended to cover is a party buying property subject to certain debt. In a short sale transaction the debt is no longer “on such property” at the time of sale, because it’s released.
For an example, assume I had a piece of property worth $300,000, with $295,000 owing on it. If I sold it to someone for $5,000 with their either taking subject to the $295,000 debt, or they actually assuming the debt, then the tax would be based on $300,000. A short sale is not that situation.
Unfortunately the statute isn’t 100% clear, but there also are not any WACs that pertain to the short sale situation.
BTW, the deed in lieu exception wouldn’t apply to a regular foreclosure, but I believe there’s a separate exception for foreclosures.
It would really be nice if they simply proposed a WAC so that we’d have some idea how this works. For example, is the triggering even the forgiveness of debt? And if so, which way? From the language of the statute I could argue that one three ways (assuming there is a taxable event).
An attorney of my acquaintance told me that he and about 900 other legal specialists recently had a conference call with the DOR regarding the application of this statute. The issue is whether this particular statute even applies due to the complexity of the short sale process (who is ultimately responsible for the taxes and how much will the taxes be?). I don’t pretend to know much about this that’s why:
Simply put: it is incumbent on real estate professionals to refer clients/potential clients to an attorney/CPA or other expert to determine a course of action.
I was discussing this issue with my sister, Karen Smith, LPO.
We agreed it is unlikely that the seller would be able to pay the excise tax, as the seller of a short sale not only gets no money from the transaction, but the bank would probably not agree to the short sale if the seller did have money.
So who gets the bill from Dept of Rev.?
From above:
“However, if the tax is not paid in full, the tax (together with any interest and penalties) becomes a lien on the real property.”
Wouldn’t it become the buyer’s debt?
It will be paid by the bank in the form of reduced net proceeds.
The scary thing is the escrow will have to base the tax payment on the payoff provided by the bank (a payoff that would otherwise be unnecessary but for this DOR position–further increasing the workload on loan servicers). It’s conceivable they might understate the payoff either to reduce the tax, or just because they realize it doesn’t affect their payment. For example, there might be several thousand dollars or attorney fees they don’t ask to update. If discovered by DOR, something that’s unlikely as to an individual case, that would leave the buyers on the hook.
DOR has implied that an option is to file a lien against the property. 🙁
Here are the notes distributed by DOR from a January 9, 2009 meeting.
Yes, I believe they have the ability to lien. When I said “scary” I meant from the buyer’s point of view because if the bank understates the payoff and the DOR finds out, it’s the buyer left holding the bag.
I’m not even sure the state could go after the bank, because they don’t sign the excise tax affidavit, and they’re not the seller. The might not be a mechanism for the state to reach the bank after the sale is complete. And I also don’t see a way for the buyer to go after the bank.
From WAR:
Washington REALTORS is pleased to announce that our meeting with the Department of Revenue has resulted in a reversal of its interpretation regarding Real Estate Excise Tax (REET) and short sales. Yesterday afternoon, the Department of Revenue contacted Washington REALTORS to inform us that DOR will issue a letter to clarify that in short sales, the Real Estate Excise Tax does not apply to debt forgiven by the seller’s lender. This decision follows a meeting that REALTORS requested of the agency in order to allow stakeholders to provide input on the interpretation of the REET statute and other policy considerations. DOR immediately responded to the request for stakeholder input and expedited its review of this issue due to its importance to home sellers and the housing market.
DOR will likely send out clarifying information today, and we will distribute the information as soon as it is received. DOR will also provide information for parties to seek REET refunds in cases where REET was paid on forgiven debt.
This is interesting. The party who would have received the amount paid in excise tax, would have been the lienholder. But the refund will likely go to the owner at the time of sale…the seller. How many owners will go to the lienholders and say, “you left some money on the table”?
I have a copy of the DOR letter announcing the change in position if anyone wants it. Thank you Bruce Fine for sending it.
Official update, posted here in the comment section, as well as in the main body of this article:
UPDATE
January 13, 2009
Department of Revenue: “After receiving extensive input from interested stakeholders and industry representatives about the nature of these transactions, we have carefully reconsidered how real estate excise tax statutes apply to these unique transactions [short sales]….we now see that these short sales are distinguishable from other transactions involving the forgiveness of debt because the seller negotiates separately with the lender for any debt reduction/forgiveness, apart from the actual purchase and sale of the property. As a result, the loan forgiveness is not “paid or delivered in return for the sale
Good. If they ended up doing this it would have resulted in much consternation. DOR would also then have go after all “consideration” taking place within a sale: reduced commissions (common) from agents going to seller, reduced escrow/title fees for sellers (builders etc), closing costs from seller to buyer which is “consideration” and so forth.
They do tax closing costs from seller to buyer, don’t they?
What about rebate brokers? I’d assume the money rebated is included in the sales price.
But I think those are different issues to some extent, because the lien items wasn’t there.
Kary, I know. I did think of the rebate brokers. All water under the bridge now.
🙂
This thread makes no sense to me. It’s obvious that the sale price which is taxed via the excise tax has never had anything to do with the forgiveness. The conclusion that it is not taxed is a big “duh”. What part of “sale price” was ambiguous?
Ardell, go back and read posts 2 and 3 above. The sales price doesn’t just include the cash paid–it also includes any debt against the property. What was tripping of the DOL wasn’t the forgiveness of debt, it was the lien. The statute is ambiguous as to the time of the lien–whether it would be counted if it’s released at time of sale, because it’s “remaining on such property at time of sale” or some such thing (see main post for the language).
Jillayne, I’m so glad you were able to write about this topic AND that DOR wised up. It’s the last thing our industry would need right now…a bunch of liens popping up on homes that were short sales for the difference of the sales price/forgiven loan amount.
I know the State’s hurting for revenue…but come on!
Bottom line, Kary…they are not taxing it, nor should they have every tried. They got paid on that when the currrent owner bought it.
Not necessarily. Many short sales are from refinancing well above the amount originally paid. But the prior sale really shouldn’t play a factor in the amount of tax for the current sale.
There was one high rise building in downtown Seattle that sold twice last year. They didn’t offer a discount because they’d already collected 2.7% on it already. 😉
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