There was an interesting article in The Orlando Sentinel this morning. It seems we have a flaw in the system for properly recording the sales prices of foreclosures sold via auction at the courthouse. The vast majority of these properties are purchased by investors with the intent of doing a quick re-hab and then "flipping" the property. Counties in Florida collect a "documentary stamp" tax based on the sales price of a piece of real property. The tax is 70 cents per $100 in sales price. Under our current system, a buyer at a courthouse foreclosure auction is given a bill of sale based on the winning bid, but is not required to present the bill of sale when reporting the sales price to the county for calculation of the documentary stamp tax. It appears many investors are over-inflating the sales prices of the properties they purchase via these auctions.
Why would they do such a thing? Simple: Greed. They are doing it for good ol' fashioned American greed. These investors can do this legally (let's leave ethically out of it) and avoid a huge chunk of capital gains tax when the property is sold. As an example: Investor purchases a property at the auction for $100,000. He reports the sale to the county for documentary stamp tax purposes as $125,000. This little move cost the investor an extra $175. Now, assume the investor put $10,000 in re-hab into the property. Now he's in it for $110,000. He puts the house back on the market and sells it for $150,000. His gross profit is $40,000, but as far as the IRS is concerned, it's only $15,000, saving the investor approximately $7,000 in capital gains taxes. Nice huh?
The article failed to mention another important motivation for falsifying sales prices by foreclosure investors: Many, if not all lenders require significantly more documentation to justify the sales price on "flip" transactions, when a sales price is significantly higher than a recent sale (be it a foreclosure auction or not) of that same property. This scheme is another way for these investors to beat the system. And finally, this practice is bad for the system as whole, because it improperly enables the recording of incorrect data in the county records.
It looks like the "flaw" will probably be fixed quickly, but how much damage has already been done? Probably millions in federal tax revenue has been lost, not to mention buyers who may have been at least partially duped on their purchase of the these properties flipped by the investor. I guess the county got a little extra revenue, which is good. Quite frankly, I'd just as soon they didn't in this case.