No Mortgage Forgiveness Act means fewer short sales


Q: I found your article very helpful. I’m a homeowner in that situation where you have to go between short (sale) and foreclosure. In your article, you intimate that if the (federal Mortgage Forgiveness Debt Relief Act of 2007) law isn’t extended, that foreclosure might possibly be a better alternative. I agree that foreclosure might be more beneficial if Congress fails to extend the act. That’s my interpretation. Was hoping you’d add yours, as it wasn’t clear to me and I’d be interested in hearing it.

— Kevin K., Las Vegas

A: As I’ve discussed in this space in recent months, the Mortgage Forgiveness Debt Relief Act was allowed to expire on Dec. 31. If Congress does not extend this act retroactively, as many hope, I expect to see fewer short sales in 2014. That’s because any amount of money a bank writes off in agreeing to sell a home as part of a short sale starting in 2014 may become taxable when sellers file their income taxes. For those who don’t know, a short sale occurs when a lender agrees to accept less than what the borrower owes on the mortgage when the borrower sells the home.

I think homeowners in this situation should consult their accountant or lawyer to find out what’s best for them. Although I worked for years as a certified public accountant, I thought the best way to answer your question would be to follow my own advice and seek help from local CPA Jason Payan, of Payan &Payan. He said:

“While there are subtle tax differences between a short sale and a foreclosure, by and large they are treated the same way for income tax purposes. The similarities are so much so that in general I tell people they are virtually the same from an income tax perspective.

With that assumption in mind, a foreclosure is oftentimes much worse than a straight short sale, the reason being, in a foreclosure the bank will usually accrue all the legal fees and foreclose fees to the price of your loan. This means that when you foreclose, you will have a significantly larger amount of cancellation of debt income to deal with.

While neither situation is desirable, at least in a short-sale situation you have more control. You can possibly negotiate a higher price for the home and thus reduce your cancellation of debt income you are exposed to. In a foreclosure situation, you are giving up all control to the bank and you are subject to their decisions and actions. You are 100 percent at their mercy.

There are two ways to look at this act’s expiration:

First, even though the law expired and you may have to pay tax on the cancellation of debt, you would only owe the IRS the tax on the income amount, whereas if you kept the loan, you would owe the bank the full value of the loan. Put another way, you can owe the Internal Revenue Service 25 percent of the deficiency or the bank 100 percent of the deficiency. Which is better?

Secondly, if this law does not apply, you may still be considered insolvent. In other words, if your debts exceed your assets the day before the short sale, you may possibly avoid the tax. I have found that many times people who are in this situation will be insolvent, or else they would not be considering short sale or foreclosure. If you are insolvent, then you can possibly avoid the tax on the deficiency.”

Even though many legislative experts and observers are predicting Congress will eventually vote later this year to extend this act, I have been advising people to play it safe. I also agree with Payan when he advises distressed homeowners to deal with their mortgage issues directly as best they can.

“While there is no magic wand to wave over the situation, it is better to take the bull by the horns and deal with things head on,” Payan said. “Human nature is to run from a problem rather than deal with it. Tax problems will never get better on their own, and oftentimes only get worse if they are ignored. Don’t bury your head in the sand. Stand and deal with the problem. With all this said, it appears that the mood with Congress is that they will extend this law and make it retroactive to the beginning of 2013. Nothing with Congress is a lock, but for what it is worth this is what people are saying.”

Send real estate questions to me at ask@glvar.org.

Heidi Kasama is the 2014 president of the Greater Las Vegas Association of Realtors and has been a local Realtor for more than 11 years. GLVAR has more than 11,000 members. For more information, visit www.lasvegasrealtor.com.

 

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