Requirements for a Deed in Lieu of Foreclosure on a Rental Property

A rental property owner may be able to avoid foreclosure by agreeing to a deed in lieu with the mortgage provider, which means surrendering the house immediately but settles the mortgage. Such deals have several requirements to be legally allowed and have tax consequences. There may also be legal consequences regarding the tenants.

A deed in lieu is a legal document signifying an agreement between a borrower and a lender with a secured loan such as a mortgage. The agreement simply means that the borrower transfers legal ownership of the secured asset, such as the house, to the lender; in return the lender formally cancels the outstanding loan. This agreement makes a foreclosure process unnecessary, which means lower costs for the lender while the borrower will not have a foreclosure listed on his credit history.

The borrower must voluntarily offer a deed in lieu. She cannot be forced to make the offer. The property cannot already be in foreclosure, and there cannot be any liens on it. A lender may ask a borrower to put a home up for sale for a certain period before accepting a deed in lieu -- which is a matter of the lender's policy rather than law.

The deed in lieu agreement must be reported on two IRS forms: 1099-A lists the fact that the lender has acquired the property, along with a market appraisal of its current value, while 1099-C details the difference between the current value of the property and the amount outstanding on the loan at the time of the deed in lieu. If there is a shortfall, it is treated as canceled debt and is thus a taxable gain for the borrower and a taxable loss for the lender.

A rental property owner who uses a deed in lieu may be able to claim a business loss on the property. This is a complicated matter -- seek professional advice on individual circumstances.

The Protecting Tenants at Foreclosure Act of 2009 means that existing leases remain valid after foreclosure and must be honored by the new owner. The only exception occurs when the new owner wants to live in the property, in which case he must give 90 days notice.

The act specifically refers to foreclosures and does not address deed in lieu cases. It has been argued that the intent of the act should cover such cases, but this argument has not yet been established by court rulings.