Poor Man's "Wash Sale" Rule?

"Buy-and-Bail" Phenomenon Observed
In Toughest Housing Markets

Stock market investors with a loss have long been able to take advantage of something called the "wash sale" rule. That allows them to stay in a stock that has dropped, but still take a tax loss. Now, something similar but much more nefarious -- called 'buy-and-bail" -- appears to be popping up in the some of the most distressed housing markets ("Some Buy a New Home to Bail on the Old"; The Wall Street Journal, 6/11/08).

Click here for the link: http://online.wsj.com/article/SB121314811278463077.html?mod=hps_us_inside_today

In the stock market version, an investor buys a second block of stock at now-lower prices to go with the first purchase. Thirty-one days later (the minimum time period allowed), they sell the original position. Result? The investor ends up with the same stake in the company, but now has a realized tax loss on the original purchase.

In the housing version, someone who bought a home that has dropped precipitously in value purchases a second home at current, much-lower prices. To qualify for the new loan, they typically represent to Lender #2 that they intend to rent out their current home (this is the fraudulent part). Once they close on the second home, they default ("bail") on the first, leaving Lender #1 in the lurch.

While such a maneuver ultimately leaves the "bailer" with wrecked credit for several years, it arguably leaves them no worse off than they would be otherwise. After all, the alternative is often wrecked credit and no home.

Understandably, lenders don't see things that way. They are rapidly updating their underwriting guidelines to screen out would-be "buy-and-bailers," and putting them on notice that, not only may they be sued for fraud, but also, depending on applicable state law, the unpaid balance on the defaulted mortgage.