ALERT!

July 11, 2013

The Mortgage Forgiveness Debt Relief Act is set to expire on January 1, 2014. Unless extended, this means that any short sale or foreclosure sale which does not occur by December 31, 2013 will not be covered by the Act. This can have disastrous tax consequences for a homeowner who may have substantial debt forgiveness income.

I previously wrote a column dealing with the Act and the value of short sales; click here to review the full column. As a quick refresher, basically, if the property qualifies as the primary dwelling of the homeowner, and otherwise meets the requirements of the Act, then the homeowner will be able to exclude the 1099 cancellation of debt income (COD income) from taxable gross income. Here is an example of how this may work:

Homeowner has a mortgage with a principal balance of $300,000. Homeowner either closes a short sale of the property for $150,000, with a waiver by the lender of the deficiency of $150,000, or the lender completes a foreclosure sale with a high bid of $150,000, and with no right to a deficiency. In either case, the homeowner will receive an IRS form 1099, which reflects that the homeowner just had $150,000 of COD income. This may be taxed at ordinary income tax rates. In Oregon, for a married couple making $50,000 a year, this COD income could mean upwards of an additional $54,000 of combined federal and state taxes!

If the Act applies, however, that married couple may be able to exclude up to the entire $150,000 of COD income (depending in part on how the loan proceeds were used).

Given how long a short sale ordinarily takes (it can easily take substantially longer than six months start to finish), and the uncertainties associated with the timing of completion of a foreclosure action (and now more than ever because of the lenders shift from nonjudicial to judicial foreclosures), any homeowner with an underwater mortgage sitting on the fence should seriously consider moving quickly in order to take advantage of the Act and close this year. Action should include speaking with a real estate broker familiar with the short sale process, as well as an attorney and tax professional in order to assess all options (particularly as there are a number of qualifying criteria under the Act and there may be other available exclusions of the 1099 income, such as the insolvency exclusion).

It is possible the Act's expiration date may be extended, but no homeowner should count on this happening. The Act has been extended twice now, most recently at the last minute for an additional one year period (from January 1, 2013 to January 1, 2014). U.S. Senators Debbie Stabenow (D-MI) and Dean Heller (R-NV) introduced the Mortgage Forgiveness Tax Relief Act (Senate Bill 1187)(for the full text, click here) on June 19, 2013, and it is presently sitting in the Senate Finance Committee. This bill would extend the Act's expiration date by two years, to January 1, 2016. However, given there is to my knowledge no other pending legislation on this point, there has been a dearth of discussion about an extension, and it has been estimated the Act has cost the government in excess of one billion dollars of lost tax revenue, a further extension of the Act should be considered questionable. Currently, the private website, www.govtrack.us, gives S. 1187 a 0% chance of being enacted.

DISCLAIMER: This column does not constitute the giving of legal advice, and your reading this column does not create an attorney/client relationship. You are encouraged to consult a lawyer or accountant should you have questions about how this information may be applicable to your particular situation.