How to commit tax fraud

how to commit tax fraud

How to Commit More Loan Fraud by Jonathan A. Goodman. Esq.

Question: There is a home in my farm area which just closed at a price 30% more than it is worth. This conclusion is based not just on my knowledge of the house and the market, but also on the listing history. The property initially went on the market six months ago. Over the six months, the price was reduced twice and the reported sale is for almost 30% more than the last list price. The property supposedly sold for more than the original listing price. What is going on here?

Response: In 2002, this column published an article entitled "How to Commit Loan Fraud" which is available for viewing at the following link: "How to Commit Loan Fraud". That article educated readers about how to avoid inadvertently committing a certain type of mortgage fraud--what this article calls "valuation loan fraud." The frequency of valuation loan fraud has increased since 2002. This article intends to help real estate professionals and sellers from inadvertently becoming caught up in such a scheme.

Generally, valuation loan fraud occurs when the contract presented to the entity funding the mortgage exaggerates the true sales price. For example, the contract shown to the mortgage funder states a nominal sales price of $400,000. However, under the table, $50,000 flows back to the buyer or the fraud promoter and the seller only nets $350,000 from the sale. (In this article, "net" means net of transaction costs, not net of debt. A seller may receive zero dollars from a sale because $350,000 pays off the seller's mortgage. While the seller may not have ever touched the $350,000, the seller benefits from the satisfaction of his mortgage and in the terminology of this article the seller netted $350,000. One tip to avoid valuation loan fraud is to focus on how much the seller receives net of transaction costs.) The mortgage investor who holds the $360,000 loan thinks it has a 90% loan to value loan ratio. Actually, the loan is for more than 100% of the property's value.

Getting a real estate deal closed is a complex process often involving two real estate brokers, a buyer, a seller, a mortgage broker, a mortgage investor, a closer, an appraiser and others. All responsible real estate professionals know that it is illegal for a seller to kick funds back to a buyer under the table. The beneficiaries of the valuation loan fraud need the cooperation of real estate professionals, most of whom receive no substantial financial benefit from the fraud, to close the deal. So the fraud promoters: (a) devise circuitous paths for the money to get back to the buyer or the fraud promoter; and/or (b) use gimmicks to create the appearance that the kick back is disclosed to the mortgage investor.

The prior article mentioned the example where the mortgage broker exaggerates the buyer's closing costs. The seller pays for those closing costs on the settlement statements and then outside of the closing, the mortgage broker rebates all or some part of the excess to the buyer. Perhaps the listing broker, the selling broker or both of them rebate the money back to the buyer.

Sometimes the path back to the buyer isn't so indirect. The pressure to "get the deal closed" can create a blind spot in otherwise responsible real estate professionals inducing them to solve a roof issue (for example) by have the seller cut a $10,000 check to the buyer at closing. Often the $10,000 rebate is memorialized through an Inspection Notice. While an adjustment to a deal through an Inspection Notice is an amendment to a contract, it feels like something which is less important to disclose to the buyer's lender. Often the duty to provide contract amendments to the lender gets sloughed.

One of the truisms about valuation mortgage fraud is that if the seller concession is shown on the HUD-1 settlement statements, then there is no fraud. But this truism is only true if the entry on the HUD-1 settlement statement is not misleading. Among the gimmicks used to create the illusion of a disclosed kick back is a debit from seller suggesting a charitable contribution. Sometimes the entry suggests that the seller is paying for a service or that the seller is paying off debt. If money is being used to satisfy real debt of the seller, then

the seller is benefitting from the funds. But in these schemes, the seller isn't benefitting from the distribution. The debit to the seller is a disguise to route money from the seller back to the buyer or fraud promoter. The payment is not part of the consideration received by the seller and the stated contract price exaggerates the seller's true net.

The written promises from the "charitable organization" or other recipient of the funds that the funds won't be distributed to the buyer are meaningless. Even if the funds aren't routed back to the buyer, some of the buyers are dupes who essentially rent their creditworthiness and social security number to the fraud promoter. In these schemes, the fraud promoter, not the buyer, pockets the bulk of the kick back.

Since 2002, suspected incidences of valuation loan fraud have grown. What appears to be mere cleverness, rather than fraud, is tempting for a seller who is frustrated with a slow real estate market. Sellers are often content to go along as the seller nets what the seller expected to net. It is especially tempting for a seller on the verge of foreclosure. The cleverness is enticing to all the professionals in the deal, even though they don't directly benefit from it, because the professionals can move a property and produce a revenue generating event. No one likes to be the stick in the mud who prevents a deal from closing. All these things contribute to the blind spots of otherwise responsible professionals.

To decrease the likelihood that you will get caught up in the momentum of these schemes, take heed of some of the common badges of valuation loan fraud:

  • Your instincts tell you something is fishy and rather than addressing the specifics of your concern, the proponents tell you "we do this all the time."
  • Someone asks the listing broker to raise the price of the property in the multiple listing service.
  • The property has been on the market a while and sells for significantly more than the last listing price.
  • The promoters from the buyer's side insist on using a specific title company to close the deal.
  • In response to your concerns, someone tells you "Well, the property appraised."
  • In response to one of your questions a mortgage broker tells you: "It's fine with me, just don't put it in writing."
  • In response to your need to amend the deal, in writing, the mortgage broker tells you: "If you need to put it into writing, do it on an Inspection Notice. However you do it, don't send it to me."
  • An offer is submitted to a listing broker together with a Notice to Correct, before the buyer has done an inspection, calling for the seller to pay money to the buyer or someone else (including someone who will supposedly repair the property).
  • A deal contemplates the payment of commissions to real estate and/or mortgage brokers which are substantially above market rates.
  • The buyer is completing the replacement transaction in a section 1031 exchange and the cost of the replacement property isn't high enough to use all of the buyer's cash from the sale of first property. If the buyer seeks to boost up the stated price of the property and get something back under the table, the parties are seeking to commit tax fraud and valuation loan fraud.

The above list isn't all inclusive, nor is it determinative. A deal with some of the above features may still not be loan fraud. Each situation needs to be evaluated on its own. Lenders can choose to make high loan to value loans, but there must be a record that lender is aware of true deal between the seller and the buyer. To avoid valuation loan fraud, the true deal must be reflected in the contract (with all its amendments) that is submitted to the buyer's lender, and all deductions from the seller's proceeds must be accurately reflected on the HUD-1.

A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.

Disclaimer -- Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.


Category: Taxes

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