Congress has recently begun its lame-duck session with a number of items on the agenda. One of the top priorities for Realtors® and underwater homeowners is likely the extension of the Mortgage Debt Relief Act (also called the Mortgage Forgiveness Tax Relief Act), which expired at the end of 2013.
What is the Mortgage Debt Relief Act? Initiated by President Bush, this IRS Act was a tax break that saves struggling homeowners from paying thousands of dollars to the IRS. As it stands right now and continuing through the end of 2013, distressed borrowers in certain situations are not be responsible for paying taxes on any of the forgiven debt associated with a short sale, a foreclosure, or a deed-in-lieu of foreclosure. (Note that the amount of debt forgiven is reported on the 1099-C, and sent to all borrowers. It is the borrower that would be responsible for addressing the debt forgiveness when completing a tax filing.)
Prior to the enactment of the Mortgage Debt Relief Act of 2007, if the short sale lender forgave $50,000 in debt, borrowers were responsible for paying the income tax (on the $50k) at their current tax rate.
Essentially, the Mortgage Debt Relief Act got rid of the fact that homeowners needed to pay income taxes on “phantom income.”
Short Sales Continue in 2015
In a November 12th Realtor® Call for Action, the National Association of Realtors® stated, “Today’s housing market is finally recovering. However, there are still too many homeowners unable to meet their mortgage obligations. Estimates show that about 5.3 million homes are still under water. In addition, there are still more than 1 million homes in the process of foreclosure.”
The Call for Action continues, “If The Mortgage Forgiveness Tax Relief Act is not enacted, hundreds of thousands of American families who did the right thing by short-selling their home or received a much needed loan reduction from their lender will have to pay income tax on phantom income.”
According to Ken Harney of the Washington Post, “Most Capitol Hill experts say there’s a good chance the bill will pass.” But, what if it does not?
Are Other Options Available to Short Sale Sellers?
While it is pretty disconcerting that taxpayers may have to pay taxes on income that they did not actually earn, there may be another way. According to the Internal Revenue Service, “A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may be excluded as income under the ‘insolvency’ exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent.” While I am not an accountant and I’d be doomed if I gave tax advice, if you or anyone you know sold as a short sale in 2014, they may want to discuss their situation with an accountant and see if there are other remedies—such as insolvency—available to them.
Currently, we are trending towards a buyer’s market throughout much of the United States. If property values do not continue to increase, we may see some more short sales in the coming year. As such, it is a good idea for Realtors® to know where the government is at with this extension, so that we can all advise our clients accordingly.