Deed in Lieu of Foreclosure

What is a Deed in Lieu of Foreclosure?

In situations in which there is no hope or little equity and no interest or hope of keeping the property or selling the property (a “short sale”), one alternative is negotiating a deed in lieu of foreclosure with your lender. The borrower may want to offer a DEED IN LIEU to avoid the lender from foreclosing via a trustee’s sale or going to court and getting a deficiency judgment against them. A deed-in-lieu of is a transfer of title back to the lender. Having more than one loan (with more than one lender) often makes this option difficult to procure. However, if your lender will consider this option, one possible benefit of this option is that the lender, in writing, agrees to not file a “1099” with the IRS on their loss which is considered regular income to the borrower—which otherwise, would be taxable to the borrower!

How does a deed in lieu work?

If a homeowner chooses to try for a deed in lieu of foreclosure in order to avoid foreclosure of their home they need to sign several legal documents such as the Agreement in Lieu of Foreclosure and a quit-claim deed. The purpose of the first document is to set out the terms and conditions of the deed-in-lieu of foreclosure, and is signed by the lender and the borrower. The second document, the quit-claim deed, conveys legal ownership of the property to the lender.

The lender will then mark the borrower's note as "paid" and provide the borrower with two documents - one which states that the debt is canceled and the other that waives the lender's right to a deficiency judgment (the lender's right to ask for the amount of the debt they are unable to recover from the sale of the home).

The agreement for deed in lieu of foreclosure is usually executed through an escrow company which will receive the borrower's note (marked as "paid") from the lender. The escrow agent will then record the deed in the property's file at the county recorder's office and send the note to the borrower, releasing the borrower from all obligations under the mortgage.

Additional Benefits

A deed in lieu transaction may be advantageous to both parties—the borrower and the bank. By the lender accepting a deed from the homeowner, the lender avoids the delays and costs related to foreclosure.

For the homeowner, he or she benefits by having predictable results. When the homeowner is irretrievably in default and has no equity in his or her property, using a deed in lieu may protect the borrower to the extent from the embarrassment and impaired credit rating a public foreclosure sale produces, and gives the borrower immunity from a possible deficiency judgment.


Some unscrupulous lenders have the borrower sign a document promising to pay any deficiencies. For example, if the home is worth $200,000 and the value is $180,000, the borrower is on the hook for the remaining $20,000. Beware!


Many lenders are not willing to consider a deed in lieu of foreclosure under the following circumstances:

  1. There is no verification of financial hardship;

  2. There are more than two loans on the distressed property.
Are the tax consequences?

Possibly. There are two types of taxes to consider when considering a deed in lieu of foreclosure:

Deed tax: Because a deed in lieu foreclosure involves the transfer of real property, the borrower may need to pay a state deed tax on the transfer of property to the lender.

The homeowner must also consider issues of capital gains taxation if the transfer is at a value in excess of the borrower’s adjusted original purchase price (whether or not the property is the borrower’s principal residence If you are considering this option, it is well-advised to seek the counsel of a good tax advisor.

To learn more about income tax in connection with canceled debt: Mortgage Debt Forgiveness Tax Relief Act (applicable till the end of 2012) and the California Mortgage Debt Relief Act, which states that a consumer does not need to pay any income tax on canceled debt (unpaid loan balance which is forgiven by lender) resulting from a deed in lieu of foreclosure. However, a borrower will need to satisfy certain conditions.

Which is better: a loan modification or a deed in lieu of foreclosure?

A loan modification because it helps you save your home and keep you and your family in the home.

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