How Does an Association Account for a Unit Acquired Through Foreclosure/Sheriff’s Sale?
How Does an Association Account for a Unit Acquired Through Foreclosure/Sheriff’s Sale?
There are more questions than answers with regards to accounting for foreclosed units and there is little in the way of absolutely accounting guidance. Below are our recommendations:
Does the Foreclosed Unit get recorded on the financial statements as an asset?
In most cases the Association does not have an asset of value. The unit is still subject to a mortgage that most likely exceeds the fair market value of the unit. GAAP (Generally Accepted Accounting Principles) states that the FMV (Fair Market Value) must be used to record the asset. GAAP also states that the mortgage cannot be included on the financial statements because it is not an obligation of the Association. However, the holder of the mortgage will ultimately foreclose on the unit to satisfy that mortgage. Thus, there may need to be a reduction in value as the asset is “impaired”. In my opinion, often the “true” value is zero as the mortgage payoff and foreclose costs exceed the FMV. If the value is determined to be zero – that is, the Association will not ultimately receive cash for the unit – then the unit should not be included on the financial statements. The Board would want to document their understanding of this matter. For example, the minutes might say “The Association received a unit in a Sheriff’s Sale that has a FMV of $250,000. However, it is our belief that the mortgage and other costs associated with the unit equal or exceed $250,000; thus, the FMV asset value is impaired. The result is that there is no net asset value that should be recorded on the books of the Association
If the Association feels that they have received a foreclosed unit and there is value in excess of the A/R and the impairment, GAAP states that a gain must be shown on the financial statements. The following assumes a $25,000 A/R, $175,000 impairment and $50,000 gain:
| DR | Foreclosed Unit (Asset) | $250,000 |
| CR | A/R | $25,000 |
| CR | Foreclosed Unit – Impairment | $175,000 |
| CR | Gain on Acquisition of Foreclosed Unit | $50,000 |
What does the Association do with the outstanding receivable once the Unit is in the Association’s possession?
We find that often the Association will want to keep track of the amount owed on the foreclosed unit in case there is even partial excess equity in the future. The Association can either leave that amount in their regular AR balance or transfer it to a separate account – A/R – Foreclosed Unit. However, the Association should consider setting up an allowance for bad debts for the total amount if collection is uncertain. The adjustments were look something like this (example assumes $25,000 A/R balance):
| DR | A/R Foreclosed Unit | $25,000 |
| CR | AR (Regular) | $25,000 |
| DR | Bad Debt Expense | $25,000 |
| CR | Allowance for Bad Debt - A/R – Foreclosed Unit | $25,000 |
Note: Whether the amount is left in regular AR or segregated into a separate account, a reasonable allowance for bad debt should be recorded.
What about monthly assessments on foreclosed units?
It is our recommendation that the monthly assessments continue to be recorded per the budget for all units – even the foreclosed unit. Then the Association can expense the nonpayment of the assessment. The assumption is that the assessment amount is the allocated percentage of all expenses for that unit. The accounting entries would be as follows:
Assessment Billing (This would be included in the normal monthly billing cycle)
| DR | A/R | $300 |
| CR | Assessment Income | $300 |
Writing off A/R to Foreclosed Unit Assessment
| DR | Foreclosed Unit Expenses (Or Rental Expense - Assessment) |
$300 |
| CR | A/R | $300 |
We suggest that this be assessment write-off segregated from bad debt, especially in the case where the Association decides to rent out the foreclosed unit (see next section).
What about when the Association decides to rent out a foreclosed unit?
Most importantly, this is a legal question. The Board and management should obtain legal advice before renting out the unit. Also, contact the Association’s insurance agent.
From an accounting standpoint, be sure and segregate rental income and all direct costs specifically associated with the rental of the unit – insurance, repairs, utilities, etc. The net rental income will be taxable so set up your account categories from the beginning to capture these costs. The Association should consider the following separate account categories:
What about monies received from a bank to clear the title?
We have had several instances where the Association has received monies from the bank to clear the title and release the unit to the mortgage holder. These monies are above and beyond AR balances. In these cases, the net proceeds (after expenses) are taxable. Examples below:
| DR | Cash | $10,000 |
| CR | Bank Settlement Income | $10,000 |
What if an Association truly obtains a unit with equity and makes a profit selling the unit – is this taxable income?
In general, the net gain is taxable to the Association. In very limited circumstances, with the approval and understanding of the Board it may be possible for the income to be membership income and potentially non-taxable. This is only a possibly option if form 1120 is filed. Many associations either do not qualify to file form 1120 or there may be too much risk to file form 1120.