affiliated lender assignment and assumption

What Is Assignment of Mortgage: What You Need to Know

We will explore the idea of mortgage assignment in this thorough guide, going over its definition, steps involved, potential consequences, and more. So read on to learn more about this important facet of the real estate market, whether you’re a homeowner, a prospective buyer, or just inquisitive about mortgages.

What is Assignment of Mortgage?

The assignment of mortgage, often simply referred to as mortgage assignment , is a legal process that involves the transfer of a mortgage loan from one party to another. This transfer typically occurs between mortgage lenders or financial institutions and is a common practice within the mortgage industry.

The Key Parties Involved

• Assignor: The person transferring the mortgage is known as the assignor. The initial lender or financial organization that gave the borrower the mortgage loan is often the assignor.
• Assignee: The assignee is the party receiving the mortgage assignment. This could be another lender or financial institution that is buying the mortgage, often as part of a financial transaction.
• Borrower: The borrower is the individual or entity that initially took out the mortgage loan to finance the purchase of a property.

Why is Assignment of Mortgage Necessary?

Assignment of mortgage occurs for various reasons, and it serves specific purposes for all parties involved.

1. Loan Portfolio Management

Mortgage assignment is a common practice used by lenders to better manage their loan portfolios. Lenders might raise funds to offer more loans or issue new mortgages by selling or transferring mortgage loans to other financial organizations. This procedure aids in keeping their portfolios risk-balanced and liquid.

2. Risk Mitigation

Lenders may also assign mortgages to mitigate risk. When they transfer a mortgage to another entity, they are essentially transferring the associated risk as well. This can be a strategic move to reduce their exposure to potential defaults or financial instability.

3. Secondary Mortgage Market

The secondary mortgage market plays a significant role in the assignment of mortgages. Many mortgages are bundled together into mortgage-backed securities (MBS) and sold to investors. Assignment of mortgages allows lenders to participate in this market, which provides additional funding for new mortgage loans.

The Assignment of Mortgage Process

The process of assigning a mortgage, or deciding to sell your mortgage , involves several steps and legal requirements. Here’s a breakdown of the typical process:

1. Agreement between Parties

The assignor (original lender) and assignee (new lender or investor) must enter into a formal agreement outlining the terms and conditions of the new mortgage assignment. This agreement includes details such as the transfer price, terms of the loan, and any specific warranties or representations.

2. Notice to the Borrower

Once the agreement is in place, the borrower is typically notified of the assignment. This notice informs them that the servicing of their mortgage, including collecting monthly mortgage payments, will now be handled by the assignee. The borrower is advised to send future payments to the assignee.

3. Recordation

In many jurisdictions, mortgage assignments must be recorded with the appropriate government office, such as the county recorder’s office. This recordation provides public notice of the transfer and ensures that the assignee has a legal claim on the property.

4. Continuation of Monthly Mortgage Payments

For the borrower, the most noticeable change is the address where monthly payments are sent. Instead of sending payment to the original lender, the borrower will send them to the assignee. It is crucial for borrowers to keep records of these changes to avoid any confusion or missed payments.

Implications of Mortgage Assignment for Borrowers

While the assignment of mortgage primarily involves lenders and investors, it can have implications for borrowers as well. Here are some important considerations for borrowers:

1. No Change in Loan Terms

Borrowers should be aware that the assignment of mortgage does not change the terms of their loan. The interest rate, monthly payments, and other loan terms remain the same. The only change is the entity to which payments are made.

2. Proper Record-Keeping

Borrowers must maintain accurate records of their mortgage payments and correspondence related to the assignment. This helps ensure that payments are correctly credited and can be vital in case of any disputes or issues.

3. Communication with the New Lender

If borrowers have questions or concerns about their mortgage after the assignment, they should reach out to the new lender or servicer. Open and clear communication can help address any issues that may arise during the transition.

4. Property Taxes and Insurance

Borrowers are still responsible for property taxes and homeowner’s insurance, even after the assignment of mortgage. These payments are typically not affected by the transfer of the loan.

The Role of Mortgage Servicers

Mortgage servicers play a crucial role in the assignment of mortgage process. This section will explore the responsibilities of mortgage servicers, their relationship with borrowers, and how they manage mortgage loans on behalf of investors or lenders.

Legal Requirements and Regulations

Assignment is subject to various legal mortgage requirements and regulations that vary by jurisdiction. Discussing these legal aspects will help readers understand the legal framework governing the assignment of mortgages in their region and how it impacts the process.

Impact on Credit and Credit Reporting

The assignment of mortgage can have implications for borrowers’ credit reports and scores. Explore how mortgage assignment can affect credit histories, reporting by credit bureaus, and what borrowers can do to protect their credit during and after the assignment.

Assignment of Mortgage vs. Assumption of Mortgage

Differentiating between assignment of mortgage and assumption of mortgage is important. This section will explain the key differences, where one party takes over the mortgage and liability, while the other party merely transfers the loan to a new lender.

Impact on Property Taxes and Insurance

Taxes and insurance are essential components of homeownership. Explain how the assignment of mortgage may affect property tax payments and the homeowner’s insurance policy, as these are often escrowed into the monthly mortgage payment.

Potential Challenges and Disputes

Discuss common challenges or disputes that can arise during or after the assignment of mortgage, such as miscommunication, incorrect payment processing, or disputes over ownership rights. Offer advice on how to handle and resolve these issues.

Foreclosure and Default Scenarios

In the unfortunate event of mortgage default, understanding how the assignment of mortgage affects foreclosure proceedings is crucial. Explain how the assignee handles foreclosures and what options are available to borrowers facing financial difficulties.

Future Trends and Innovations

Explore emerging trends and innovations in the mortgage industry related to the assignment of mortgages. This could include the use of blockchain technology, digital mortgages, or other advancements that may impact the process.

In the complex world of real estate and mortgage financing , the assignment of mortgage plays a pivotal role in the movement of funds and management of risk. It allows lenders to efficiently manage their portfolios, mitigate risk, and participate in the secondary mortgage market. For borrowers, understanding the process and implications of mortgage assignment is essential to ensure the smooth continuation of their monthly mortgage payments.

As you navigate the world of homeownership or consider entering it, remember that the assignment of mortgage is a routine occurrence designed to benefit all parties involved. By staying informed and maintaining open communication with your lender or servicer, you can ensure that your mortgage loan remains a manageable and secure financial commitment.

In summary, purchase of mortgage is a vital mechanism within the mortgage industry that facilitates the transfer of mortgage loans from one party to another. This process helps lenders manage their portfolios, mitigate risk, and participate in the secondary mortgage market.

For borrowers, it means a change in the entity collecting their monthly mortgage payments but typically does not alter the terms of the original loan. Keeping accurate records and staying informed about the transition are crucial steps to ensure a smooth experience for homeowners. So, whether you’re a homeowner, lender, or investor, understanding assignment of mortgage is key to navigating the real estate landscape effectively.

This article is for informational purposes only and does not constitute legal, tax, or accounting advice.

Written by Alan Noblitt

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Assignment and Assumption: Single Assignment of Loans | Practical Law

Assignment and Assumption: Single Assignment of Loans

Practical law standard document 2-382-1269  (approx. 12 pages).

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• GAINS & LOSSES

Taxing the Transfer of Debts Between Debtors and Creditors

• C Corporation Income Taxation
• NOL & Other Tax Attributes
• Individual Income Taxation

T he frequent transfer of cash between closely held businesses and their owners is very common. If the owner works in the business, the transfer is likely to be either a salary to a shareholder/employee or a Sec. 707(c) guaranteed payment to a partner. Alternatively, the transfer may be a loan. As long as the true substance of the transaction is a loan, it will be respected for tax purposes. 1

The cash flow is not exclusively from the businesses to the owner. Many owners prefer to capitalize their closely held business with a combination of equity and debt. Once again, these loans will be respected and not reclassified as equity if they are bona fide loans.

In the normal course of business, these loans are repaid. The receipt of the repayment will be tax free except to the extent it is interest. However, in difficult economic conditions, many of these loans are not repaid. To the extent that the creditor cancels the obligation, the debtor has cancellation of debt (COD) income under Sec. 61(a)(12). This income is taxable unless the taxpayer qualifies for an exclusion under Sec. 108. In other cases, the debt is transferred between the parties either as an independent transaction or part of a larger one. This article reviews these transactions.

Two basic types of transfers have created significant tax issues. In the first, the debtor transfers the debt to the creditor. If the debtor is the owner of a business and the business is a creditor, the transfer appears to be a contribution. If the business is the debtor and the owner is the creditor, the transfer can be a distribution, liquidation, or reorganization. The other type of transfer is from the creditor to the debtor. Again, the transaction can take the form of a contribution if the creditor is the owner, or it can take the form of a distribution, liquidation, or reorganization if the creditor is the business.

Debtor-to-Creditor Transfers

Corporations.

The two seminal cases that established the framework for analyzing the transfer of a debt obligation from a debtor to a creditor are Kniffen 2 and Edwards Motor Transit Co. 3 Arthur Kniffen ran a sole proprietorship and owned a corporation. The sole proprietorship borrowed money from the corporation. For valid business reasons, Kniffen transferred the assets and liabili ties of the proprietorship to the corporation in exchange for stock of the corporation, thereby transferring a debt from the debtor to the creditor. The transaction met the requirements of Sec. 351.

The government argued that the transfer of the debt to the creditor was in fact a discharge or cancellation of the debt (a single step), which should have been treated as the receipt of boot under Sec. 351(b) and taxed currently. The taxpayer argued that the transfer was an assumption of the debt and, based on Sec. 357(a), should not be treated as boot.

The Tax Court acknowledged that the debt was canceled by operation of law. However, it did not accept the government’s argument as to the structure of the transaction. Instead, it determined that two separate steps occurred. First, the corporation assumed the debt. This assumption was covered by Sec. 357(a). After the assumption, the interests of the debtor and creditor merged and the debt was extinguished. Since the transfer was not for tax avoidance purposes, Sec. 357(b) did not apply. The result was a tax-free Sec. 351 transaction, except to the extent that the assumed debt exceeded the bases of the assets transferred, resulting in gain under Sec. 357(c). This decision established the separation of the debt transfer from its extinguishment.

Edwards Motor Transit Co. cites, and is considered to have adopted, the approach in Kniffen . For valid business reasons, the owners of Edwards created The Susquehanna Co., a holding company, and transferred Edwards’ stock to it under Sec. 351. Susquehanna borrowed money from Edwards to meet certain financial obligations. To eliminate problems that arose from having a holding company owning the stock of an operating company, the owners merged Susquehanna into Edwards under Sec. 368(a)(1)(A). The government acknowledged that the basic transaction was a nontaxable merger. However, the government wanted the company to recognize income as a result of the cancellation or forgiveness of the debt. The Tax Court ruled for the taxpayer, on the grounds that the debt transfer (from debtor to creditor) was not a cancellation of the debt. The ruling cited Kniffen as authority for this conclusion.

On its surface, Edwards Motor Transit affirmed the decision and reasoning in Kniffen . The Tax Court stated, “The transfer by the parent corporation of its assets to Edwards [its subsidiary] . . . constituted payment of the outstanding liabilities . . . just as surely as if Susquehanna had made payment in cash.” This statement relied on both Kniffen and Estate of Gilmore. 4 In Gilmore , a liquidating corporation transferred a receivable to its shareholder who happened to be the debtor. In that case, the court ruled the transaction was an asset transfer and not a forgiveness of debt. The court based its conclusion in large part on the fact that no actual cancellation of the debt occurred.

The statement in Edwards Motor Transit quoted above, however, is inapposite to the conclusion in Kniffen . A payment is not a transfer and assumption of a liability. Since Susquehanna was deemed to have used assets to repay the debt, the Tax Court should have required Susquehanna to recognize gain to the extent that the value of the assets used to repay the debt exceeded their bases. The conclusions in Kniffen and Edwards are consistent only in their holdings that these debt transfers were not cancellations of debts that would result in COD income. In Kniffen, the court ruled that the debt was assumed and then extinguished. In Edwards, the court ruled that the extinguishment of the debt constituted repayment.

It is possible that the Tax Court reached the correct outcome in Edwards Motor Transit but for the wrong reason. In Rev. Rul 72-464, 5 a debtor corporation merged into the creditor corporation in a tax-free A reorganization under Sec. 368(a)(1)(A). The ruling concluded that the debtor corporation did not recognize any gain or loss on the extinguishment of the debt within the acquiring corporation. General Counsel Memorandum (GCM) 34902 6 provided the detailed analysis behind the conclusion.

The GCM cited both Kniffen and Edwards 7 and adopted their underlying rationale. Specifically, it concluded that the basic transaction (the reorganization) results in a transfer of the debt to the acquiring corporation. It is after the transfer that the debt is extinguished by the statutory merger of interests. The transfer is an assumption of debt, which is nontaxable under Sec. 357(a). Therefore, the transferor (debtor corporation) recognizes no gain or loss.

This is exactly what happened in Ed wards . The debt was assumed, not repaid. Therefore, the Tax Court should have reached the conclusion that the transaction was nontaxable under Sec. 357(a) and not have relied on the questionable authority of Estate of Gilmore 8 or concluded that the debt was repaid.

Liquidations

The transactions discussed up to this point have been either tax-free corporate formations (Sec. 351) or tax-free reorganizations (Sec. 361). In a different transaction that is likely to occur, the creditor/shareholder liquidates the debtor corporation.

If the transaction is not between a parent and its subsidiary, taxability is determined by Secs. 331 and 336. Prior to 1986, the outcome might have been determined by Kniffen and Edwards . With the repeal that year of the General Utilities 9 doctrine (tax-free corporate property distributions) and the enactment of current Sec. 336, the outcome is straightforward. Under Sec. 336, the debtor corporation that is liquidated recognizes its gains and losses. Whether the liquidated corporation is treated as using assets to satisfy a debt requiring the recognition of gain or is treated as distributing assets in a taxable transaction under Sec. 336, all the gains and losses are recognized.

The taxation of the shareholder is a little more complex. First, the shareholder must determine how much it received in exchange for the stock. The most reasonable answer is that the shareholder received the value of the assets minus any debt assumed and minus the face amount of the debt owed to it by the liquidated corporation. This amount is used to determine the gain or loss that results from the hypothetical sale of stock under Sec. 331. Second, the shareholder must determine what was received for the debt, whether assets or the debt itself. The amount received in payment of the liquidated corporation’s debt is a nontaxable return of capital. If the shareholder is deemed to have received the debt itself, then the debt is merged out of existence. The basis of all the assets received should be their fair market value (FMV) under either Sec. 334(a) or general basis rules.

If the liquidated corporation is a subsidiary of the creditor/shareholder, the results change. Under Sec. 337, a subsidiary recognizes neither gain nor loss on the transfer of its assets in liquidation to an 80% distributee (parent). Sec. 337(b) expands this rule to include distributions in payment of debts owed to the parent corporation. Therefore, the subsidiary/debtor does not recognize any gain or loss.

The parent corporation (creditor) recognizes no gain or loss on the liquidation of its subsidiary under Sec. 332. The basis of the transferred property in the hands of the parent is carryover basis. 10 This carry­over basis rule also applies to property received as payment of debt if the subsidiary does not recognize gain or loss on the repayment. 11 In other words, the gain or loss is postponed until the assets are disposed of by the parent corporation.

One important exception to the nonrecognition rule is applied to the parent corporation. Under Regs. Sec. 1.332-7, if the parent’s basis in the debt is different from the face amount of the debt, the parent recognizes the realized gain or loss (face amount minus basis) that results from the repayment. Since this regulation does not mention any exception to the rules of Sec. 334(b)(1), the parent corporation is required to use carryover basis for all the assets received without adjustment for any gain or loss recognized on the debt.

This discussion of liquidations assumes that the liquidated corporation is solvent. If it is insolvent, the answer changes. The transaction cannot qualify under Secs. 332 and 337. The shareholder is not treated as receiving any property in exchange for stock; therefore, a loss is allowed under Sec. 165(g). The taxation of the debt depends on the amount, if any, received by the shareholder as a result of the debt.

Partnerships

The taxation of debt transfers involving partnerships is determined, in large part, by Secs. 731, 752, and 707(a)(2)(B). Specifically, the taxation of transfers by debtor partners to the creditor/partnership is determined by the disguised sale rules of Sec. 707(a)(2)(B), whereas transfers by debtor partnerships to a creditor/partner fall under Secs. 731 and 752.

Sec. 707(a)(2)(B) provides that a transfer of property by a partner to a partnership and a related transfer of cash or property to the partner is treated as a sale of property. The regulations specify the extent to which the partnership’s assumption of liabilities from the partner is treated as the distribution of the sale price.

Regs. Sec. 1.707-5 divides assumed liabilities into either qualified liabilities or unqualified liabilities. A qualified liability 12 is one that:

• Was incurred more than two years before the assumption;
• Was incurred within two years of the assumption, but was not incurred in anticipation of the assumption;
• Was allocated to a capital expenditure related to the property transferred to the partnership under Temp. Regs. Sec. 1.163-8T; or
• Was incurred in the ordinary course of business in which it was used, but only if all the material assets of that trade or business are transferred to the partnership.

The amount of qualified recourse liabilities is limited to the FMV of the transferred property reduced by senior liabilities. Any additional recourse liabilities are treated as nonqualified debt.

If a transfer of property is not otherwise treated as part of a sale, the partnership’s assumption of a qualified liability in connection with a transfer of property is not treated as part of a sale. The assumption of nonqualified liabilities is treated as sale proceeds to the extent that the assumed liability exceeds the transferring partner’s share of that liability (as determined under Sec. 752) immediately after the partnership assumes the liability. If no money or other consideration is transferred to the partner by the partnership in the transaction, the assumption of qualified liabilities in a transaction treated as a sale is also treated as sales proceeds to the extent of the transferring partner’s share of that liability immediately after the partnership assumes the liability. 13 Following the assumption of the liability, the interests of the debtor and creditor merge, thereby extinguishing the debt. The result is that generally the full amount of these assumed liabilities are part of the sale proceeds. 14

The assumed liabilities that are not treated as sale proceeds still fall under Sec. 752. Since the transaction results in a reduction of the transferor’s personal liabilities, the taxpayer is deemed to have received a cash distribution equal to the amount of the debt assumed under Sec. 752(b). Given that the debt is immediately extinguished, no amount is allocated to any partner. The end result is that the transferor must recognize gain if the liability transferred exceeds the transferor’s outside basis before the transaction, increased by the basis of any asset transferred to the partnership as part of the transaction.

A partnership may have borrowed money from a partner and then engaged in a transaction that transfers the debt to the creditor/partner. The first question is whether the initial transaction is a loan or capital contribution. Sec. 707(a) permits loans by partners to partnerships. The evaluation of the transaction is similar to one to determine whether a shareholder has loaned money to a corporation or made a capital contribution. The factors laid out in Sec. 385 and Notice 94-47 15 should be considered in this analysis.

Assuming the debt is real and it alone is transferred to the creditor/partner, the outcome is straightforward. The partner is treated as having made a cash contribution to the partnership under Sec. 752(a) to the extent that the amount of debt exceeds the amount allocated to the partner under the Sec. 752 regulations. If part of the debt is allocated to other partners, these other partners are treated as receiving a deemed cash distribution.

If the transfer is part of a larger transaction, then the analysis is a little more complex. The transfer of the other assets is governed by Secs. 737, 731, and 751. Sec. 737 requires a partner to recognize gain if, during the prior seven years, the partner had contributed property with built-in gain to the partnership and the current FMV of the distributed property exceeds the partner’s outside basis. The partner is treated as recognizing gain in an amount equal to the lesser of (1) the excess (if any) of the FMV of property (other than money) received in the distribution over the adjusted basis of such partner’s interest in the partnership immediately before the distribution reduced (but not below zero) by the amount of money received in the distribution, or (2) the net precontribution gain of the partner. The outside basis is increased by the amount of the deemed contribution because the partner assumed a partnership liability. After any gain under Sec. 737 is determined, the general distribution rules of Secs. 731 and 751(b) apply to the transaction. In effect, the transfer to a creditor/partner of a partnership debt owed to the partner is treated the same as any liability assumed by the partner. The extinguishment of the debt should not result in additional tax consequences.

Creditor-to-Debtor Transfers

In addition to debtor-to-creditor transfers, there are creditor-to-debtor transfers. The outcome of these transactions is determined by the two-step analysis in Kniffen . The creditor is treated as having transferred an asset to the debtor/owner. After the transfer, the interests of the debtor and creditor merge, resulting in the extinguishment of the debt. This extinguishment is generally nontaxable since the basis of the debt and the face amount are equal. 16 The result changes if the basis in the hands of the creditor and the adjusted issue price of the debtor are not equal. 17

One of the initial pieces of guidance that addressed this question was Rev. Rul. 72-464. 18 In this ruling, the debt was transferred in a nontaxable transaction. Consequently, the recipient (the debtor) had a carryover basis in the debt. Since this basis was less than the face amount, gain equal to the difference was recognized. This ruling did not explain the reasoning behind the gain recognition or the potential impact if the value of the debt was different from its basis. 19 These items were addressed in Rev. Rul. 93-7. 20

Rev. Rul. 93-7 analyzed a transaction between a partnership and a partner, here designated P and A , respectively. A was a 50% partner. This percentage allowed A to not be a related party to P under Sec. 707(b). P also had no Sec. 751 assets, and A had no share of P ’s liabilities under Sec. 752. These were excluded because they did not affect the reasoning behind the taxation of debt transfers. A issued a debt with a face amount of $100 for $100. P acquired the debt for $100. When the debt was worth $90, it was distributed to A in complete redemption of its interest, which had an FMV of $90 and outside basis of $25. In other words, a creditor/partnership distributed debt to the debtor/partner.

The debt was an asset, a receivable, in the hands of P . When it was distributed to A , P determined its taxation under Sec. 731(b), which provides that no gain or loss is recognized by a partnership on the distribution of property. The application of Sec. 731(b) in this transaction followed directly from Kniffen , which treated the transfer of a debt as a separate transaction from any extinguishment that follows the transfer. Under Sec. 732, A ’s basis in the transferred debt was $25. 21

The basis rules of Sec. 732 assume that a built-in gain or loss on distributed property is realized and recognized when the recipient disposes of the property. In this situation, the distributed debt was extinguished, and therefore no future event would generate taxable gain or loss. Consequently, this extinguishment became a taxable event. In this specific case, A recognized gain of $65 ($90 FMV – $25 basis) and COD income of $10 ($100 face − $90 FMV.) The ruling did not spell out the reasoning for the recognition of both gain and COD income. It is the correct outcome based on Regs. Sec. 1.1001-2. Under that regulation, when property is used to satisfy a recourse obligation, the debtor has gain equal to the difference between the value of the property and its basis, and COD income equal to the difference between the amount of debt and the value of the property used as settlement. The distributed debt is property at the time of the distribution, and the rules of Regs. Sec. 1.1001-2 should apply.

In Rev. Rul. 93-7, the value of the debt was less than the face amount. A debt’s value could exceed its face amount. In that case, the revenue ruling indicated, a deduction for the excess value may be available to the partner as a result of the deemed merger. In Letter Ruling 201105016, 22 the IRS ruled that a taxpayer was entitled to a deduction when it reacquired its debt at a premium as part of a restructuring plan. Rev. Rul. 93-7 cited Regs. Sec. 1.163-4(c)(1), and Letter Ruling 201105016 cited Regs. Sec. 1.163-7(c). Both regulations state that the reacquisition of debt at a premium results in deductible interest expense equal to the repurchase amount minus the adjusted issue price. Regs. Sec. 1.163-4(c)(1) applies to corporate taxpayers, while Regs. Sec. 1.163-7(c) expanded this treatment to all taxpayers. Based on these regulations and the treatment of the distribution as an acquisition of a debt, an interest expense deduction should be permitted when the value exceeds the amount of debt, whereas COD income is recognized when the value is less than the amount of the debt.

In Rev. Rul. 93-7, the partnership was the creditor, and the debt was transferred to a debtor/partner. The reverse transaction can occur, in which a creditor/partner transfers debt to the debtor/partnership in exchange for a capital or profits interest. Sec. 721 applies to the creditor/partner. Therefore, no gain or loss is recognized. However, Sec. 108(e)(8)(B) applies to the debtor/partnership. Sec. 108(e)(8)(B) provides that the partnership recognizes COD income equal to the excess of the debt canceled over the value of the interest received by the creditor. This income is allocated to the partners that owned interests immediately before the transfer. The partnership does not recognize gain or loss (other than the COD income) as a result of this transaction. 23 The value of the interest generally is determined by the liquidation value of the interest received. 24 If the creditor receives a profits interest, the liquidation value is zero, and therefore the partnership recognizes COD income equal to the amount of debt transferred.

Corporate Transactions

Debt transfers between corporations and shareholders are just as likely as transfers between partners and partnerships. If the transferor is a shareholder or becomes a shareholder as a result of the transaction, Secs. 1032, 118, and 351 provide basic nontaxability. However, Sec. 108 overrules these sections in certain cases.

If the shareholder transfers the debt to the corporation as a contribution to capital, Sec. 108(e)(6) may result in the recognition of COD income by the corporation. Under Sec. 108(e)(6), the corporation is treated as having satisfied the indebtedness with an amount of money equal to the shareholder’s adjusted basis in the indebtedness. Therefore, the corporation has COD income amount equal to the excess of the face amount of the debt over the transferor’s basis in the debt immediately prior to the transfer. In most cases, the face and basis are equal, and no COD income is recognized. If the transfer is in exchange for stock, Sec. 108(e)(8)(A) provides that the corporation is treated as having satisfied the indebtedness with an amount of money equal to the FMV of the stock. Therefore, the corporation recognizes COD income equal to the excess of the face value of the debt over the value of the stock received. In many cases, the value of the stock is less than the debt canceled, and therefore COD income is recognized. Sec. 351 provides that 80% creditor/shareholders recognize neither gain nor loss if the debt is evidenced by a security. If Sec. 351 does not apply, the creditor/shareholder may be able to claim a loss or bad-debt deduction.

Rev. Rul. 2004-79 25 provides a detailed analysis of the transfer of debt from a creditor corporation to a debtor shareholder. The analysis is similar to the one for partnership distributions covered by Rev. Rul. 93-7, discussed previously.

Modifying the facts of Rev. Rul. 2004-79, assume that a shareholder borrows money from his corporation. The face amount of the debt is $1,000, and the issue price is $920. The original issue discount (OID) of $80 is amortized by both the corporation and the shareholder. At a time when the adjusted issue price and basis are $950 but the FMV is only $925, the corporation distributes the debt to the shareholder as a dividend.

From the corporation’s point of view, this is a property dividend. Rev. Rul. 2004- 79 cites Rev. Rul. 93-7, but it could just as easily have cited Kniffen . As a property dividend, the transaction’s taxa tion to the corporation is governed by Sec. 311. Since the value in the revenue ruling was less than the basis, the corporation recognized no gain or loss. If the value had appreciated, the corporation would have recognized gain equal to the appreciation.

The shareholder receives a taxable dividend equal to the value of the debt; consequently, the debt has a basis equal to its FMV of $925. Since the debt is automatically extinguished, the shareholder is treated as having satisfied an obligation in the amount of $950 with a payment of $925. Therefore, the shareholder must recognize $25 of COD income.

A second fact pattern in the revenue ruling is the same, except the value of the distributed debt is $1,005. Under these facts, the shareholder would be entitled to an interest expense deduction under Regs. Sec. 1.163-4 or 1.163-7 in the amount of $55 ($1,005 − $950). In other words, the shareholder is deemed to have reacquired its own debt for a payment equal to the basis that the distributed debt obtains in the transaction.

The conclusions of Rev. Rul. 2004-79 are consistent with those in Rev. Rul. 93-7. They follow the reasoning of Kniffen .

Another transaction that could occur involving shareholder debt is a liquidation of the corporation, resulting in a distribution of the debt to the debtor/shareholder. The results should be similar to those in Rev. Rul. 2004-79. The corporation that distributes the debt is taxed under Sec. 336. Therefore, the corporation recognizes gain or loss depending on the basis of the debt and its FMV. This is the same result as in the dividend case, except that the loss is recognized under Sec. 336 instead of being denied under Sec. 311. The shareholder’s basis in the debt is its FMV under Sec. 334(a). The shareholder recognizes COD income or interest expense, depending on whether the basis is less than or greater than the adjusted issue price of the debt. These results flow from the regulations under Secs. 61 and 163 and are consistent with the conclusions in the above revenue rulings.

The results change slightly if the liquidation qualifies under Secs. 332 and 337. The IRS discussed these results in Chief Counsel Advice 200040009. 26 Sec. 332 shields the parent from recognition of income on the receipt of the debt. Sec. 337 shields the liquidating corporation from recognizing gain or loss on the transfer of the debt to its parent corporation. The basis is carryover basis under Sec. 334(b). Then, because the debt is extinguished, the parent recognizes either COD income or interest expense on the extinguishment of the debt. As in the prior revenue rulings and Kniffen , the extinguishment has to be a taxable event because the elimination of the carryover basis prevents the parent corporation from having a taxable transaction in the future involving this debt. These results are consistent with prior decisions.

The results discussed for a parent/subsidiary liquidation should also apply if the debtor/corporation acquires a corporation that owns its debt in a nontaxable asset reorganization. In this case, Sec. 361 replaces Secs. 332 and 337. The extinguishment of the debt is a separate transaction that should result in recognition of income or expense.

Acquired Debt

So far, this article has discussed transactions between the debtor and creditor. Now it turns to how the holder of the debt acquired it. In many cases, the holder acquired the debt directly from the debtor, and the acquisition is nontaxable. In other situations, the debt is outstanding and in the hands of an unrelated party. The holder acquires the debt from this unrelated party. In these cases, Sec. 108(e)(4) may create COD income.

Under Sec. 61, if a debtor reacquires its debt for less than its adjusted issue price, the debtor has COD income. Sec. 108(e)(4) expands on this rule: If a party related to the debtor acquires the debt, the debtor is treated as acquiring the debt, with the resulting COD income recognized. Related parties are defined in Secs. 267(b) and 707(b)(1).

The regulations provide that the acquisition can be either direct or indirect. A direct acquisition is one by a person related to the debtor at the time the debt is acquired. 27 An indirect acquisition occurs when the debtor acquires the holder of the debt instrument, where the holder of the debt acquired it in anticipation of becoming related to the debtor. 28 The determination of whether the holder acquired the debt in anticipation of becoming related is based on all the facts and circumstances. 29 However, if the holder acquires the debt within six months before the holder becomes related to the debtor, the acquisition by the holder is deemed to be in anticipation of becoming related to the debtor. 30

In the case of a direct acquisition, the amount of COD income is equal to the adjusted issue price minus the basis of the debt in the hands of the related party. In the case of indirect acquisitions, the calculation depends on whether the debt is acquired within six months of being acquired. 31 If the holder acquired the debt within six months of being acquired, the COD income is calculated as if it were a direct acquisition. If the holder acquired the debt more than six months before being acquired, the COD income is equal to the adjusted issue price minus the FMV of the debt instrument on the date that the holder is acquired.

When a debtor reacquires its own debt, in addition to reporting COD income, the debtor has the debt extinguished as a result of the merger of interests. When a related party acquires the debt, the debtor has COD income, but the debt remains outstanding. In these cases, the debtor is treated as issuing a new debt instrument immediately following the recognition of the COD income for an amount equal to the amount used to calculate the COD income (adjusted basis or FMV 32 ). If this issue price is less than the stated redemption price at maturity of the debt (as defined in Sec. 1273(a)(2), the difference is OID that is subject to the amortization rules of Sec. 1272.

Rev. Rul. 2004-79 provides a simple example of this transaction. In the ruling, a parent corporation, P , issued $10 million of debt for $10 million. After issuance, S , a subsidiary of P , purchased the debt for $9.5 million. Under Regs. Sec. 1.108-2(f), P had to recognize $500,000 of COD income ($10 million face − $9.5 million basis to S ). After this recognition, P was treated as having issued the debt to S for $9.5 million. Therefore, $500,000 of OID was amortizable by P and S . If S later transfers the debt to P , the previously discussed rules determine the taxation of the transfer using S ’s basis ($9.5 million + amortized OID).

Secs. 61 and 108(e)(4) apply only if the debt is acquired for less than the adjusted issue price. If the acquisition price is greater than the adjusted issue price, the acquiring party treats this excess as premium and amortizes it, thereby reducing the amount of interest income recognized by the holder.

Installment Obligations

An installment obligation differs from other obligations in that the holder recognizes income when cash is collected in payment of the obligation. The rules describing the taxation of installment obligations were rewritten as part of the Installment Sales Revision Act of 1980, P.L. 96-471. Under old Sec. 453(d) (new Sec. 453B(a)), if the holder of an installment obligation distributes, transmits, or disposes of the obligation, the taxpayer is required to recognize gain or loss equal to the difference between the basis in the obligation and the FMV of the obligation. There is an exception to this rule for distributions in liquidation of a subsidiary that are exempt from taxation under Sec. 337.

Prior to the Code revision, the regulations permitted the transfer of installment obligations without gain recognition if the transaction was covered by either Sec. 721 or 351. 33 Although the regulations have not been revised for the Code change, the IRS continues to treat Secs. 721 and 351 as overriding the gain recognition provision. 34

If the transaction results in transfer of the obligation either from the creditor to the debtor or from the debtor to the creditor, the tax result changes. The seminal case is Jack Ammann Photogrammetric Engineers, Inc. 35 In it, the taxpayer created a corporation to which he contributed $100,000 in return for 78% of the corporation’s stock. He then sold his photogrammetry business to the corporation for $817,031. He received $100,000 cash and a note for $717,031. He reported the sale under the installment method. When he was still owed $540,223 on the note, he transferred it to the corporation for stock of the corporation worth $540,223. He reported this as a disposition under Sec. 453(d) and recognized the deferred gain. Later, he filed a claim for refund, arguing that Sec. 351 prevented recognition of the deferred gain. After allowing the refund, the IRS assessed a deficiency against the corporation, arguing that the corporation came under Sec. 453(d). The corporation argued that, under Sec. 1032, it was not taxable. The Tax Court ruled for the IRS.

The Fifth Circuit reversed the decision. The underlying reasoning was that the disposition by the shareholder and the extinguishment of the debt in the hands of the corporation were separate transactions. The extinguishment did not fall under Sec. 453(d). The court indicated that the IRS should have assessed the tax against the shareholder.

Following this case, the IRS issued Rev. Rul. 73-423. 36 In this ruling, a shareholder transferred an installment obligation from Corporation X back to the corporation in a transaction described in Sec. 351. The ruling concluded that the transfer was a satisfaction of the installment agreement at other than face value under Sec. 453(d)(1)(A) and that the shareholder was required to recognize gain without regard to Sec. 351. The corporation had no gain or loss under Sec. 1032 and Ammann .

Sec. 453(d) is now Sec. 453B(a), and the rule has not changed. Therefore, if a creditor transfers an installment obligation to the debtor in an otherwise tax-free transaction, the obligation is treated as satisfied at other than its face value, and the creditor is required to recognize gain or loss as discussed in Rev. Rul. 73-423. 37

New Sec. 453B(f) covers transactions in which installment obligations become unenforceable. This section covers the extinguishment of an installment debt through a merger of the rights of a debtor and creditor. The Code treats these transactions as dispositions of the obligation with gain or loss recognized. When the debtor and creditor are related, the disposition is at FMV but no less than the face amount.

If the debtor of an installment obligation engages in a transaction in which the creditor assumes the debt, the results are consistent with those of transactions involving obligations other than installment notes. The debtor is deemed to have received cash equal to the amount of the debt. This is fully taxable unless exempted by Sec. 357, 721, or a similar provision. The creditor falls under Sec. 453B(f), with the extinguishment treated as a taxable disposition of the obligation for its FMV (which for related parties is no less than the face amount).

Business entities often incur debts to their owners, and, conversely, the owners incur liabilities to their business entities. In numerous transactions these obligations are canceled for consideration other than simple repayment of the debt. Based on Kniffen , these transactions are treated as a transfer of consideration followed by an extinguishment of the debt. If a shareholder’s debt to his or her controlled corporation is transferred to that corporation along with assets, the transaction may be tax free under Secs. 351 and 357(a). If a shareholder/creditor receives the related corporate debt in a distribution or liquidation, Sec. 311 or 336 determines the corporation’s taxation.

The cancellation of a partner’s debt to the partnership is generally governed by the distribution rules, including the constructive sale or compensation rules of Sec. 707(a)(2). When a partner cancels the partnership’s debt, the partner has made a contribution to capital. This can have consequences to all partners since the total liabilities are decreased and the partners’ bases are decreased under Sec. 752.

In most cases the merger of debtor and creditor interests is nontaxable. However, if the basis of the debt or receivable does not equal the face amount of the debt, income or loss is recognized. The exact amount and character of the income or loss depends on factors discussed in this article. It is important for the tax adviser to identify those cases in which the debt transfer is not tax free.

1 Invalid loans to shareholders have been reclassified as dividends.

2 Kniffen , 39 T.C. 553 (1962).

3 Edwards Motor Transit Co. , T.C. Memo. 1964-317.

4 Estate of Gilmore , 40 B.T.A. 945 (1939).

5 Rev. Rul. 72-464, 1972-2 C.B. 214.

6 GCM 34902 (6/8/72). The GCM also refers to Sec. 332, which will be dis cussed later.

7 As the GCM points out, by using Sec. 357(a), taxpayers could achieve the same outcome in C reorganizations.

8 See Chief Counsel Advice 200040009 (10/6/00), which suggests Estate of Gilmore ’s requirement of a formal cancellation of debt before COD income is recognized may no longer be valid.

9 General Utilities & Operating Co. v. Helvering , 296 U.S. 200 (1935).

10 Sec. 334(b)(1).

12 Regs. Sec. 1.707-5(a)(6).

13 If the partnership transfers money or other consideration in the transaction, the amount treated as sales proceeds may be limited under Regs. Sec. 1.707-5(a)(5)(i)(B).

14 Under Regs. Sec. 1.707-5(a)(3)(ii), a partner’s share of liabilities is reduced by liabilities assumed that are anticipated to be reduced. Based on Kniffen and Edwards , the reduction will be anticipated.

15 Notice 94-47, 1994-1 C.B. 357.

16 See, e.g., IRS Letter Ruling 8825048 (3/23/88).

17 The transaction that gives rise to the difference and the taxation that results are discussed later.

18 Rev. Rul. 72-464, 1972-2 C.B. 214. Although this is a debtor-to-creditor transfer, the result is the same.

19 See GCM 34902 (6/8/72).

20 Rev. Rul. 93-7, 1993-1 C.B. 125.

21 If the partnership makes a Sec. 754 election, the partnership has a Sec. 734 adjustment of $75 ($100 inside basis – $25 basis after distribution).

22 IRS Letter Ruling 201105016 (2/4/11).

23 Regs. Sec. 1.108-8, effective Nov. 17, 2011.

24 See the Regs. Sec. 1.108-8(b)(2) safe-harbor rule.

25 Rev. Rul. 2004-79, 2004-2 C.B. 106.

26 CCA 200040009 (10/6/00).

27 Regs. Sec. 1.108-2(b).

28 Regs. Sec. 1.108-2(c)(1).

29 Regs. Sec. 1.108-2(c)(2).

30 Regs. Sec. 1.108-2(c)(3).

31 Regs. Secs. 1.108-2(f)(1) and (2).

32 Regs. Sec. 1.108-2(g).

33 Regs. Sec. 1.453-9(c)(2).

34 See IRS Letter Rulings 8824044 (3/22/88) and 8425042 (3/19/84).

35 Jack Ammann Photogrammetric Engineers, Inc. , 341 F.2d 466 (5th Cir. 1965), rev’g 39 T.C. 500 (1962).

36 Rev. Rul. 73-423, 1973-2 C.B. 161.

37 Although this revenue ruling involved a corporation, the IRS believes the same rule applies to partnerships. Treasury is currently working on a revision of the regulations to clarify the results. See the preamble to Regs. Sec. 1.108-8, T.D. 9557 (11/17/11).

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PRACTICE MANAGEMENT

CPAs assess how their return preparation products performed.

This assignment and assumption of agreement is between , an individual a(n) (the " Assignor ") and , an individual a(n) (the " Assignee ").

The Assignor and , an individual a(n) (the " Other Party "), entered an agreement dated (the " Agreement "), a copy of which is attached as Exhibit A .

Under section of the Agreement relating to assignments, the Assignor may assign the Agreement to the Assignee and the Other Party wants to permit this assignment.

The parties therefore agree as follows:

1. ASSIGNMENT.

The Assignor assigns to the Assignee of all its rights in, and delegates to the Assignee all of its obligations under, the Agreement. This transfer will become effective on (the " Effective Date "), and will continue until the current term of the Agreement ends.

2. ASSUMPTION OF RIGHTS AND   DUTIES.  

After the Effective Date, the Assignee shall assume all rights and duties under the Agreement. The Assignor will have no further obligations under the Agreement The Assignor will remain bound to the Other Party under the Agreement for the following purposes: . However, the Assignor remains responsible for obligations accruing before the Effective Date.

3. INCONSISTENCY.

If there is a conflict between this assignment and the Agreement, the terms of this assignment will govern.

4. AGREEMENT CONTINUANCE.

Except as expressly modified and supplemented by this assignment, all other terms in the Agreement remain in full effect and continue to bind the parties, including the prohibition against further assignments without the Other Party's express written consent.

5. ASSIGNOR'S REPRESENTATIONS .

The Assignor represents that:

• (a)  it is the lawful and sole owner of the interests assigned under this assignment;
• (b)  it has not previously assigned its rights under the Agreement;
• (c) the interests assigned under this assignment are free from all encumbrances; and
• (d)  it has performed all obligations under the Agreement.

6. INDEMNIFICATION.

• (a) Of Other Party by Assignee. The Assignee shall indemnify the Other Party against all claims, actions, judgments, liabilities, proceedings, and costs, including reasonable attorney's fees and other costs of defense, resulting from the Assignee's performance under the Agreement after the Effective Date.
• (b) Of Other Party by Assignor. The Assignor shall indemnify the Other Party against all claims, actions, judgments, liabilities, proceedings, and costs, including reasonable attorneys' fees and other costs of defense, resulting from the Assignor's performance under the Agreement before the Effective Date. With respect to claims, actions, judgments, liabilities, proceedings, and costs resulting from the Assignee's performance under the Agreement after the Effective Date, the Other Party shall look first to the Assignee to satisfy those claims, actions, judgments, liabilities, proceedings and costs, including reasonable attorneys' fees and other costs of defense.
• (c) Of Assignee by Assignor. The Assignor shall indemnify the Assignee against all claims, actions, judgments, liabilities, proceedings, and costs, including reasonable attorneys' fees and other costs of defense, that may after the Effective Date be suffered by or asserted against the Assignee because of the Assignor's failure to have performed, before the Effective Date, all of the Assignor's obligations under the Agreement or because of any other claims accruing before the Effective Date that may be asserted with respect to the Agreement.
• (d) Of Assignor by Assignee. The Assignee shall indemnify the Assignor against all claims, actions, judgments, liabilities, proceedings, and costs, including reasonable attorneys' fees and other costs of defense, that may after the Effective Date be suffered by or asserted against the Assignor because of the Assignee's failure to have performed, after the Effective Date, all of the Assignor's obligations under the Agreement or because of any other claims accruing after the Effective Date that may be asserted with respect to the Agreement.

7. COUNTERPARTS; ELECTRONIC SIGNATURES.

• (a) Counterparts. The parties may execute this assignment in any number of counterparts, each of which is an original but all of which constitute one and the same instrument.
• (b) Electronic Signatures. This assignment, agreements ancillary to this assignment, and related documents entered into in connection with this assignment are signed when a party's signature is delivered by facsimile, email, or other electronic medium. These signatures must be treated in all respects as having the same force and effect as original signatures.

8. SEVERABILITY.

If any provision contained in this assignment is, for any reason, held to be invalid, illegal, or unenforceable in any respect, that invalidity, illegality, or unenforceability will not affect any other provisions of this assignment, but this assignment will be construed as if the invalid, illegal, or unenforceable provisions had never been contained in it, unless the deletion of those provisions would result in such a material change so as to cause completion of the transactions contemplated by this assignment to be unreasonable.

No waiver of a breach, failure of any condition, or any right or remedy contained in or granted by the provisions of this assignment will be effective unless it is in writing and signed by the party waiving the breach, failure, right, or remedy. No waiver of any breach, failure, right, or remedy will be deemed a waiver of any other breach, failure, right, or remedy, whether or not similar, and no waiver will constitute a continuing waiver, unless the writing so specifies.

10. ENTIRE AGREEMENT.

This assignment, together with the Agreement, constitutes the final agreement of the parties. It is the complete and exclusive expression of the parties' agreement with respect to its subject matter. All prior and contemporaneous communications, negotiations, and agreements between the parties relating to the subject matter of this assignment are expressly merged into and superseded by this assignment. The provisions of this assignment may not be explained, supplemented, or qualified by evidence of trade usage or a prior course of dealings. No party was induced to enter this assignment by, and no party is relying on, any statement, representation, warranty, or agreement of any other party except those set forth expressly in this assignment. Except as set forth expressly in this assignment, there are no conditions precedent to this assignment's effectiveness.

11. HEADINGS.

The descriptive headings of the sections and subsections of this assignment are for convenience only, and do not affect this assignment's construction or interpretation.

12. EFFECTIVENESS.

This assignment will become effective when all parties have signed it. The date this assignment is signed by the last party to sign it (as indicated by the date associated with that party's signature) will be deemed the date of this assignment.

13. NECESSARY ACTS; FURTHER ASSURANCES.

Each party shall use all reasonable efforts to take, or cause to be taken, all actions necessary or desirable to consummate and make effective the transactions this assignment contemplates or to evidence or carry out the intent and purposes of this assignment.

[SIGNATURE PAGE FOLLOWS]

Each party is signing this assignment on the date stated opposite that party's signature.

The Other Party hereby acknowledges and consents to the above assignment and assumption, and as of its effective date, releases the Assignor from all future obligation and liability under the Agreement. In executing its consent to this assignment, the Other Party does not release the Assignor from any claims or remedies it may have against the Assignor under the Agreement.

In executing its consent to this assignment, the Other Party does not release the Assignor from any claims or remedies it may have against the Assignor under the Agreement.

[PAGE BREAK HERE]

EXHIBIT A Attach copy of original agreement

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Assumption Transactions in Texas

by David J. Willis J.D., LL.M.

What is an assumption?

The essential features of an assumption are that (1) the buyer takes title by means of an assumption deed (with or without a vendor’s lien retained by the seller) containing either general or special warranties; and (2) the buyer promises to pay all or part of the balance of existing indebtedness against the property, a promise that may or may not be secured by a deed of trust to secure assumption that gives the seller a non-judicial foreclosure remedy in the event of nonpayment.

Additional documents such as an assumption agreement may also be needed. If the buyer is an investor, some sort of authority—either a special power of attorney or a property management letter—should be secured so that the investor can later obtain payoff information.

In terms of transactional documentation, there is a barebones unsecured approach that minimizes potential liability for a buyer, and there is a secured approach (involving a vendor’s lien and deed of trust to secure assumption) that maximizes protection for the seller.

Can an assumption be accomplished without the lender’s permission?

Yes . An assumption transaction may be accomplished with or without consent of the lender. The transaction involves only a title transfer (a conveyance by deed in which the lender does not participate) and a promise by the buyer to take over payments on an existing debt. This promise is between buyer and seller and does not involve the lender on the existing loan .

As far as a lender’s ability to prevent an assumption transaction, no such mechanism exists. There is no point in the process where a lender has the legal ability to intercept and prevent the assumption transaction from closing, nor is there a means (judicial or non-judicial) by which a lender can require that a completed assumption transaction be unwound.

The majority of assumption transactions occur unofficially without consent from the lender. Title is transferred and the buyer makes a promise to the seller that he or she will make payments on the existing note as they fall due. The specifics of how payments will be handled and when they will begin is often handled in a separate assumption agreement between buyer and seller.

Buyer’s Liability on Existing Note

After the assumption is closed (assuming lender pre-approval was not obtained), what is the buyer’s liability to the lender on the existing note? There is none. Promising to pay the existing indebtedness in an assumption transaction is only a pledge from buyer to seller, not to the lender.

The only way one becomes obligated to a lender is to sign a note to that lender. Similarly, the only way one is released from a note obligation is for the lender to sign a release of note and lien.

Assumable Versus Non-Assumable Loans

Most loans today are referred to as non-assumable. This is contrasted with certain loans in years past (VA loans, for instance) that could be assumed just by paying an assumption fee and notifying the lender of a new owner. It was a simple substitution.

Those days are gone. Even so, does the term non-assumable mean that an owner cannot deed the property to someone else? No. The concept of title is separate from the concept of debt. An owner of real property is normally entitled to transfer title whenever and to whomever he or she wishes. Doing so, however, does not relieve the selling owner from responsibility to pay the existing note (since the seller has not been released) nor does it obligate the buyer to start making payments on the note (since the buyer has not signed the lender’s note). A typical deed transfers title—that’s all. Obligations to a lender under existing indebtedness remain exactly as they were before the sale.

The assumability issue is relevant only in determining whether or not the lender will allow substitution of one borrower for another. In other words, will the lender let the seller off the hook for the debt and substitute the name of the buyer as the new borrower? The answer is no. Lenders want a new buyer to either (1) apply, qualify, and pay fees to assume the existing loan or (2) get a new loan. That is the nature of the lending business.

Due-on-Sale

Before engaging in an assumption without lender consent, one should check the wording of the deed of trust securing the existing loan. If it contains a due-on-sale clause (and nearly all of them do) then its wording needs to be carefully evaluated.

The due-on-sale clause in paragraph 18 of the commonly-used FannieMae deed of trust states: “If all or any part of the Property or any interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may [italics added] require immediate payment in full. . . .” A lender is thus given the option to accelerate the note if it chooses. Lender action is entirely discretionary.

The due-on-sale clause in the FHA deed of trust is worded differently. Paragraph 9(b) states that the lender “ shall [italics added], if permitted by applicable law . . . require immediate payment in full. . . .”

Most residential deeds of trust merely give the lender a choice as to whether to accelerate the note or not. It becomes a business decision by the lender to either (1) take no action or (2) accelerate and proceed to foreclosure. For now, the majority of lenders are choosing not to accelerate so long as the loan remains current; but there is always the possibility that economic factors (rising interest rates, for example) could influence lenders to make a different choice. There is no method of doing an assumption transactions that eliminates the due-on-sale risk.

Additional note: if an owner transfers title without lender consent, is he or she guilty of breaching the deed of trust? Committing an illegal act? No . In nearly all residential cases, a change of title without notifying the lender is not a breach or violation of anything. It only results in giving the lender a choice as to whether or not to accelerate. It does not render the owner civilly or criminally culpable in any way.

Seven-Day Notice Rule

Property Code Section 5.016 contains a notice rule that applies in the case of unapproved assumptions. This section requires that seven-days advance notice be sent to the lender, theoretically providing the lender with an opportunity to call the loan due. There is, however, no stated penalty for failing to give the notice.

In most cases when this notice is given (often to the loan servicer) there is no immediate response or action.

Lender consent is not required under this statute.

Is an assumption the same thing as a wrap?

No. In a wrap, a new borrower-lender relationship is created, one between buyer and seller. The buyer becomes obligated to the seller on a new wraparound note that is secured by a new wraparound deed of trust. As to the existing note (the wrapped note), the seller remains obligated to continue monthly payments until it is paid and released. The wrap and the wrapped obligations coexist.

By contrast, in an assumption, no new note is created. The buyer instead makes a promise to the seller (not the lender) that the buyer will pay the existing note.

What is the difference between assumption and “subject to?”

In an assumption, the buyer promises to pay the existing debt. By contrast, in a sub2, the buyer takes title but expressly disclaims any obligation to pay the seller’s debt , even though that debt is secured by an existing lien on the property. There is no agreement to assume anything. A sub2 buyer can choose to keep the existing loan current or not.

A typical assumption clause might read: “As further consideration, Grantee promises to keep and perform all of the covenants and obligations of the Grantor contained in the Assumed Note and the Assumed Deed of Trust. Grantee shall commence payments on the Assumed Note on or before the next regular due date under the Assumed Note.”

A typical “subject to” clause might read: “This conveyance is made subject to any and all indebtedness of Grantor and liens against the Property including but not limited to that certain note described as follows: [details of note]. Grantee does not assume payment of this or any other indebtedness of Grantor.”

A sub2 transaction is usually entered into by investors who want to do a short-term flip (perhaps after doing some rehab work) without incurring any responsibility for the existing note in the process. The objective is usually to sell the property quickly to a new buyer who will then pay off the existing note at a traditional title company closing.

Assumptions tend to be more appropriate for those who intend to hold a property for a while.

Is title insurance available for unapproved assumptions?

Sometimes but usually not. Title companies are conservative institutions that avoid potential liability so most assumptions will need to be closed without title insurance in the office of an attorney familiar with creative transactions. If a buyer is curious about the status of title (and an investor-buyer should always be curious about the chain of title) then a title report should be obtained and examined before closing.

What if there is more than one existing loan?

An assumption transaction may still occur if there are multiple loans and liens. The notes may even be payable to different lenders. A buyer may agree to assume payment of existing first and second liens, for example. The assumption deed will recite that the buyer is promising (to the seller) to make payments on two notes rather than one.

The more complicated the assumption, the more important it is to have a stand-alone assumption agreement that covers the details.

What about a short-term agreement to pay the note?

This is a hybrid, not a true assumption but not a true sub2 transaction either. An investor-buyer may make a promise to the seller to assume payments on the existing loan for a limited time—a year, perhaps, or until the property is resold to a third party. This is certainly feasible but the legal wording can be tricky. Example: “Although buyer does not promise to pay the existing note, it is agreed between buyer and seller that buyer will nonetheless make a limited number of monthly payments on said note commencing [date] and continuing for a period of up to 12 months or when the property is resold to a buyer who discharges the existing note, whichever is less.” In this way, the seller may feel safer about selling on an assumption while the investor-buyer limits liability to a short-term payment obligation.

What documents are involved in an assumption?

At the contract stage, one should use the TREC 1-4 contract with the Loan Assumption Addendum attached. This Addendum unfortunately does not have a special provisions section that allows for creative approaches, so a customized special provisions addendum prepared by an attorney will almost certainly be necessary as well.

As to the closing documents, there are two approaches:

(1) Seller-Oriented . The first approach is seller-oriented since it includes security for the seller, namely the right to foreclose and take the property back if assumption terms are not complied with. Documents required are a warranty deed with vendor’s lien and a deed of trust to secure assumption. Additional documents—a separate assumption agreement, a property management letter sent to the lender, and a power of attorney in favor of the buyer—may be included. These supplementary documents are advisable, if for no other reason than it may become necessary for the buyer to inquire about a payoff, and without evidence of legal authority (a document signed and acknowledged by the original borrower) a lender will not supply this confidential information. An alternative might be to obtain the seller’s online login information so as to access the lender’s website.

(2) Oriented in Favor of Investor-Buyer. The second, simpler option is more favorable to an investor-buyer. It is used when the seller does not require (or perhaps even care about) taking security for the assumption. If the seller’s credit is already in poor shape, the seller may just want to deed the property over to an investor-buyer and hope to never hear any more about it. For this approach, a single document—an assumption deed without a vendor’s lien—is sufficient to complete the transfer title. Getting a simple assumption deed like this should always be an investor-buyer’s preferred approach.

What if the buyer defaults on his promise to pay the existing note?

If the seller obtained security in the form of a deed of trust to secure assumption—option (1) above—then non-judicial foreclosure (on the courthouse steps) is available if the buyer defaults on the assumption promise. Texas has an expedited non-judicial foreclosure process set out in Property Code Section 51.002. This statute requires that a homeowner be given at least a 20-day notice of default and intent to accelerate the note if the default is not timely cured. A judicial foreclosure (by means of a lawsuit) is also an available option.

If, on the other hand, the seller merely signed an assumption deed without a vendor’s lien and without a deed of trust to secure assumption, the seller is probably out of luck when it comes to a quick remedy for buyer default. In the absence of actual fraud committed by the buyer, the seller is probably out of luck entirely.

Order of Preference: Creative Approaches to Assumptions

From the point of view of an investor-buyer, there is a definite order of preference when it comes to structuring and documenting these sorts of transactions:

(1) take title to the property by means of a “subject to” deed (which of course is not an assumption at all);

(2) take title by means of a hybrid deed—basically a sub2 deed that promises to make payments on the existing note for a limited period (six months for example) or until the property is resold—so the assumption portion of the transaction is strictly limited in duration;

(3) take title by means of an assumption deed without a vendor’s lien (and unsupported by a deed of trust) which promises, as part of the consideration for the transfer, that the investor-buyer will pay the existing debt with payments commencing on a certain date;

(4) take title by means of a stand-alone assumption deed with a vendor’s lien (but without a deed of trust to secure assumption in favor of seller); or

(5) take title by means of an assumption deed with vendor’s lien secured by a deed of trust to secure assumption in favor of the seller and supported by an assumption agreement along with a special power of attorney (to enable the buyer to communicate with the lender).

The guidance of an attorney experienced in this area should always be obtained in preparing documents, since it can be easy to mix or confuse assumption language with language relating to “subject to.”

Non-Recourse Clause

From the point of view of an investor-buyer, the closing documents for every transaction in this category—one that involves a title change where there is existing debt—should as a safety measure include a non-recourse clause against the general assets of the investor debtor.

Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.

Copyright © 2023 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com .

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Assumption, Assignment and Sale of SBA 7(a) Loans

https://youtu.be/mSZoxM5QVNo

You have a business with an SBA guaranteed 7(a) loan and now you are looking to sell the business.  What about the loan?  Can you simply assign the loan and have the buyer assume the loan in your sale documents without anything more?  Generally speaking, the SBA will need to approve the assumption and certain requirements must be met: 1. Unless the assumption is part of a workout or the loan is in liquidation status, the proposed assumptor must meet the applicable 7(a) Loan eligibility requirements in the most current version of the SBA’s standard operating procedures; 2. The proposed assumptor should be the primary owner of the business; 3. The proposed assumptor should have business experience and management skills that are equal to or better than the Borrower's; 4. The proposed assumptor must have a satisfactory credit history; 5. The proposed assumptor must have the ability to repay the SBA loan in full; 6. No collateral should be released; 7. No collateral should be subordinated except as otherwise provided with regard to funds that will be used to make improvements to the collateral that will maintain or increase its value; 8. The proposed assumption should not have a negative impact on the operation of the business; 9. The proposed assumption must not have a negative impact on the recoverable value of the collateral; 10. The existing collateral should be adequate to secure the loan, if not and whenever possible, additional collateral should be required as a condition for the assumption; 11. Existing Obligors must not be released without SBA’s prior written approval; 12. The terms of the assumption must be set out in a written agreement signed by all of the parties to the agreement; 13. The terms of the assumption must include a "due on sale or death" clause that prohibits any future assumption of the SBA loan; and 14. The terms of the assumption must not include a real estate contract, i.e., the seller may not retain title to the property until an agreed upon amount is paid.

If you are facing an SBA loan default, contact Protect Law Group today at www.sba-attorneys.com or 1-888-756-9969 to schedule your FREE initial consultation.

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Clients personally guaranteed an SBA 7(a) loan.  The SBA referred the debt to the Department of Treasury, which was seeking payment of $487,981 from our clients.  We initially filed a Cross-Servicing Dispute, which was denied.  As a result, we filed an Appeals Petition with the SBA Office of Hearings and Appeals asserting legal defenses and supporting evidence uncovered during the discovery and investigation phase of our services.  Ultimately, the SBA settled the debt for $25,000 - saving our clients approximately $462,981.

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$375,000 SBA 504 LOAN - SBA OIC CASH SETTLEMENT

Client personally guaranteed SBA 504 loan balance of $375,000.  Debt had been cross-referred to Treasury at the time we got involved with the case.  We successfully had debt recalled to the SBA where we then presented an SBA OIC that was accepted for $58,000.

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Comments on the assignment of the out-of-plane vibrations of the trans-buta-1,3-diene molecule

• Published: 07 April 2011
• Volume 66 , pages 8–12, ( 2011 )

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• Yu. N. Panchenko 1 &
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An assignment of the out-of-plane vibrations of the trans -buta-1,3-diene molecule was performed by analysis of the isotopic shifts of wavenumbers in the methylene moieties =CHX, where X = H, D or T. A suggestion for the mutual reassignment of the wavenumbers belonging to the twisting vibration of the methylene moiety =CH 2 and the out-of-plane vibration of the methine moiety =CH— was shown to be incorrect.

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Yu. N. Panchenko & A. V. Abramenkov

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Original Russian Text © Yu.N. Panchenko, A.V. Abramenkov, 2011, published in Vestnik Moskovskogo Universiteta. Khimiya, 2011, No. 1, pp. 11–15.

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Panchenko, Y.N., Abramenkov, A.V. Comments on the assignment of the out-of-plane vibrations of the trans-buta-1,3-diene molecule. Moscow Univ. Chem. Bull. 66 , 8–12 (2011). https://doi.org/10.3103/S0027131411010093

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Received : 20 August 2010

Published : 07 April 2011

Issue Date : February 2011

DOI : https://doi.org/10.3103/S0027131411010093

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