Cal. Code Civ. P. § 726, often referred to as the one-action rule, has many facets. Relevant to this article is the “security-first” rule which requires “a secured creditor to proceed against the security before enforcing the underlying debt”; the penalty for failing to do so is waiver of the security.
In practical terms, this means a creditor secured by property has to either pursue foreclosure or file a lawsuit on the debt. The aforementioned ‘or’ is an exclusive ‘or’ meaning the lender has to pick one or the other and cannot pick both options. Consequently, this is what’s typically referred to as an “election of remedies.” Read more…
In re Frazier, 2012 Westlaw 812387 (E.D. Cal. March 2012), the District Court has affirmed the bankruptcy court’s ruling allowing a residential lien strip notwithstanding no discharge in the chapter 13. The court says, “Instead of discharge, the Court agrees with the underlying Bankruptcy Court and finds plan completion is the appropriate end to Appellees’ Chapter 20 case. The lien strip will become permanent not upon a discharge, as would happen in a typical Chapter 13 case, but upon completion of all payments as required by the plan. See In re Blenheim, 2011 WL 6779709 (Bankr.W.D.Wash. Dec.27, 2011).”
A reader asks: If a second lien is stripped in a chapter 13, and the mortgage lender issues a 1099 before the discharge is entered, is the cancellation of debt income still excluded from gross income under IRC Section 108?
Answer: The debt is not uncollectible until there is a discharge that gets rid of it. The lender can’t issue the 1099, even if there is a confirmed plan that hoses it on 70% of the debt, because the debtor may flake out and never complete the plan, win the lottery, and HELOC lender can collect. But lenders aren’t always rational about their issuance of 1099s. If the debtor gets a 1099 during or after a year when he was in bankruptcy, the debtor should file Form 982 with his return explaining why the 1099 doesn’t represent taxable income.
IRS can’t assess the tax on COD income until either the taxpayer reports it on his return, or it goes through the deficiency process audit, Tax Court, the whole enchilada. FTB can assess as soon as it thinks it’s being abused, but it would just about never open an audit on this issue before the IRS would.
A colleague writes:
PC has $150k of equity in her home. Taxes owed are dischargeable. I know if the IRS filed a Notice of Lien, the lien remains but what if no Notice of Lien was filed – is the unrecorded lien still attached to the equity?
The IRS does indeed have a silent lien against the equity in the house, but it disappears in bankruptcy. Because the bankruptcy trustee takes over the property with the powers of a judgment creditor, and because there was no Notice of Federal Tax Lien on file, the trustee’s interest trumps the IRS’s interest. The debtor gets to keep the equity in the house. After the discharge is entered, the taxes are discharged, and the IRS can no longer attach the house.