Short Sale Flipping-Is it fraud or illegal?

The topic of Short Sale Flipping has been a topic of debate for years.  Short Sale Flipping is when you buy a short sale property and re-sell on the same day for a profit.  The question comes up a lot about whether this can be done and if it’s legitimate.  There are several things to consider when doing short sale flipping.  First it’s not illegal or considered fraud to flip a short sale as long as you do it right.  You must give written disclosure to the bank that you intend to re-sell the property for a profit.  This can be in your contract.

The obstacles that you would need to overcome are the bank restrictions on re-selling the house.  Most banks have caught on to investors re-selling the short sale’s for a profit and they don’t like it.  So they have now implemented forms for the buyers, sellers, and realtors to sign to prevent these transactions.  You will see addendum's to the contract, Anti Flip Affidavits, as well as Arms Length Transaction Disclosures.  All of these documents will state that you agree not to resell the property for a specific period of time.  This is typically 30-90 days.  I would expect to get something like this for almost every short sale transaction you process.  Even local banks are having us sign these documents.  You can try to negotiate with the bank to not sign the addendum if you want, but most banks are going to want you to sign it.

So when does buying a short sale become fraud.  It becomes fraud if you do agree to the terms the bank specified and you violate them.  For example if you agreed to not sell the property in less than 30 days and you do sell it this could potentially be seen as fraud.  The banks do random checks by their legal team after a sale to make sure a subsequent sale hasn’t taken place.  If they do see an immediate re-sale they can threaten to unwind the transaction and return the wire.  The bank can press charges.  The judge will be one to decide whether it was fraud or not.

Some people try to sneakily get around the restrictions by being creative.  They would do LLC transfers or buy it in a trust.  However there is no case law that I know of that proves that this actually is considered fraud.  This could potentially still be deemed as fraud by a judge.  The definition of fraud is “an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation.”  So if you intentionally did the LLC transfer or bought in a trust just to deceive the short sale lender for a personal gain, this may be seen as fraud.

There are also some state laws you need to be aware of regarding short sales.  For Example Colorado has the Colorado Foreclosure Protection Act.  If you are doing a short sale, in order to re-sell the property you must give full disclosure to the short sale bank regarding the terms of the subsequent sale.  So what short sale lender is going to agree to a subsequent sale?  In order to sell the home on a short sale without giving disclosure you must hold the property for at least 14 days.

I like to play it safe since I do a lot of short sale transactions. I just hold the property for the specified time period and then re-sell.  My exit strategy is fix and flip and fix and hold anyway.  So it will take me approx 90 days to sell a fix and flip and if I buy as a rental then I won’t even have to worry.  My best advice is just don’t violate any bank rules or try to get around it and don’t violate any state laws regarding short sale flipping.  If you do plan of being in the short sale business it is highly recommended to seek an attorney’s legal advice.