The Mortgage Forgiveness Debt Relief Act is set to sunset on December 31, 2012 and it may not get extended. The law, first enacted in 2007, allows homeowners who have received principal reductions on their mortgages as the result of loan modifications, short sales or foreclosures to avoid income taxation on the amounts forgiven.
Here's a little history and how it works. Before 2007, all cancellations of debt by creditors (i.e., mortgage, personal or auto) were considered taxable events under the federal tax code. If you owed $500,000, but paid off only $350,000 through an agreement with the lender, the $150,000 difference would be treated as ordinary income and taxed at regular rates. The Act was due to expire on December 31, 2010 but was extended through 2012. Under this Act, you can avoid taxation on forgiven mortgage debt amounts up to $1 million for single filers, or $2 million if married filing jointly. To be eligible, the debt must be cancelled by a lender in connection with a mortgage restructuring, short sale, deed-in-lieu of foreclosure or foreclosure. But the transaction must be completed no later than Dec. 31, 2012.
Loss of this tax help will endanger huge numbers of distressed mortgage arrangements in the months (and years) ahead including those qualifying under the recent $25 billion mortgage settlement (see my previous blog post for more details on the settlement). Any borrower receiving any principal reduction or debt forgiveness may face hefty and ill-timed taxable income hits in the event this law is not extended.
The clock is ticking and that impending deadline has real estate and tax professionals on edge. Bottom line - if you are thinking about a short sale or foreclosure, do it now!
And if you are considering a short sale, some benefits to a seller instead of foreclosure might be:
1. A slight benefit in the credit score.
This is especially true if short sale is approved while the borrower is current (it can and does happen and is also a significant benefit in terms of ability to get a new home mortgage (in as little as 2 years).
2. If the seller has two mortgages.
A short sale provides a vehicle for resolving both debts at once, and a quality short sale negotiator will in most instances be able to settle the second for less than if the borrower let the first foreclose and then circled back to negotiate and settle the second.
3. A borrower still has a reasonable shot at getting a short sale completed before 12/31/12, when the principal residence exemption to Cancellation of Debt (COD) income is still in effect, versus a foreclosure, which will probably not happen until 2013 at this point, thus increasing the chances of income tax liability, particularly if there is a second lien that must be settled too.
In conclusion, every situation is unique and your mileage may vary, but short sale can be an excellent alternative to foreclosure, and something you may want to consider.
Come meet with me to discuss if you are a good candidate for a short sale, and how to take advantage of The Mortgage Forgiveness Debt Relief Act while it still exists!