Real estate deal gone bad may require criminal probe

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Q. I purchased a 1900s Victorian house in October 2006 from a man who had bought it earlier that same year to "flip." This owner had a business sign prominently displayed in the front yard, leading me and others who watched the renovation of this house to believe it was a legitimate business venture. We closed on the house before the work was completed, and after about a month of returning to work on the house, the seller just stopped coming back.

Besides leaving work unfinished (a breach of contract), his work quality at the end spiraled downward, leaving me with nearly $30,000 in unfinished/substandard work, per professional appraisal. I tried to get my city's housing office involved, as I felt it had not properly conducted their building inspections but have met with no satisfaction. All pre-purchase inspections were set up by the lender (who was coincidentally also his lender) and I was never notified so I could be present.

I sought counsel from an attorney, but before we could get the ball rolling, the seller filed for bankruptcy. I was not listed as a creditor in his filing. In the bankruptcy paperwork, this guy listed the sale of this house as a personal sale. I've been to several attorneys and nobody wants to touch this with a 10-foot pole unless I'm willing to front all legal fees, which I've been assured will run me more than my losses.

My question is this: Can I declare any of this loss on my taxes? If so, when and how? Do I have to wait until I sell? Is there any other avenue I haven't explored, with hopes of recovering any of my losses?

A. The events that you describe are very unusual and the questions complex. First, it is surprising that the lender would allow a closing on the property without the seller completing the improvements or without requiring the seller to fund an escrow account of 1 1/2 times the estimated expense to complete the improvements. This is a standard practice.

Additionally, the lender's inspections of the property should have involved an adequate standard of care showing that the improvements met code and permit inspection requirements were completed. Based on your letter, it appears that the seller made a substantial profit on the property and may be linked to the lender or associates of the lender to extract such favorable and lax supervision. You were hurt by the lack of a reasonable standard of care on the part of the lender. You should discuss this aspect of the case with an attorney.

Also, issues of mortgage fraud may be present. This should be investigated with your state's attorney general and real estate commission if the seller is a licensed real estate agent or broker. If the seller is licensed, many states have consumer recovery funds from which you can seek compensation. The FBI Financial Crimes Unit is reporting a rapid rise in suspicious activity reports filed by housing consumers at risk for mortgage fraud. You may want to look into this avenue as well.

You should contact your city council member and get to the bottom of the property inspection problems and obtain any documentation that you can on the inspection reports and the seller's failure to meet code standards and complete the project. You may be able to negotiate a loan forbearance with the lender to suspend or alter mortgage payments.

With the large number of predatory lending and mortgage fraud issues the nation is facing, many states and cities have established counseling services to help consumers. Funds are also available to help consumers. Talk with your accountant about deductions that you can take on the purchase of the property.


Dr. Thomas Musil is the director of the Shenehon Center for Real Estate at the University of St. Thomas in Minneapolis. He has more than 25 years' experience as a broker, analyst, consultant and expert witness in real estate litigation and arbitration disputes. E-mail questions to: tamusil@stthomas.edu . Please include your name, city and state.


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