Foreclosure Tax Exemption Extended for Short Sales

Posted by: on Wed, Jan 09, 2013

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Homeowners in American now have one more year to complete a short sale and benefit from a federal tax break that was set to expire last week. Buried in the 157-page legislation is an extension of the Mortgage Debt Relief Act, which allows borrowers to exclude loan debt forgiven in a short sale, foreclosure or loan modification from counting as income on their taxes.

The act has saved struggling homeowners untold millions since it began in 2007. Tuesday’s approval of the American Taxpayer Relief Act of 2012 extends its deadline to Jan. 1, 2014.sThis is very important news for homeowners whose short sales and “deeds in lieu of foreclosure” had not been concluded by December 31, 2012, and who were facing a substantial income tax bill if the exemption had expired and not been renewed. It also will benefit many homeowners whose properties are foreclosed in 2013, as well as individuals who obtain a “principle reduction” loan modification on their home mortgages.

Homeowners facing foreclosure won’t have to worry about an extra-large tax bill after losing their house or getting a loan modification. At least not for another year.

The down-to-the-wire action left real estate professionals, not to mention those borrowers in the know, nervous it could fall through the cracks.

Forgiven debt could add thousands of dollars to an already struggling homeowner’s tax bill. That might have turned some off to seeking an alternative, potentially dragging out the foreclosure only to end up with a higher tax liability regardless.

Through the past year, homeowners have increasingly avoided foreclosure through loan modifications and short sales. The shift is driven in large part by renewed energy in the housing market, as well as a multistate mortgage servicing settlement that requires banks to direct more customers toward foreclosure alternatives. Nevada has added laws requiring lenders to mediate with borrowers in good faith before allowing the foreclosure process to proceed.

The closer we got to the end of the year, the increase in pre-foreclosure sales was accelerating in most states out of fear a deal would not be reached in time. Short sales are complicated transactions that require not just agreement between the buyer and the seller, but also the lender that owns the seller’s loan. In a short sale, the lender agrees to accept the home’s market value to pay off the mortgage even though it’s less than the amount owed. The negotiations can last for months.

The act now expires Jan. 1, 2014, along with some of the government programs that encourage loan modifications and short sales. But that just sets Congress up to face another foreclosure cliff. Many anticipate that due to the number of homeowners who are underwater on their home mortgages, another extension will likely be needed again at the end of this year.

In normal situations existing before the current financial crisis, the mortgagor would be subject to ordinary income tax on the forgiven debt. This is considered under the tax code to be “deemed income.” In Nevada, the unsecured portion of a loan written off in a short sale can often be in excess of $100,000. This can create a substantial tax liability. Going over the fiscal cliff would have allowed a temporary provision in the federal tax code that exempted home short sales starting in 2007 from the tax liability for the imputed income from the cancelled mortgage debt. Buried in the financial cliff legislation was the extension of the exemption for another year. Our hypothetical couple will not receive a tax bill.

The new law does contain certain limitations. For example, the debt must have been on a primary home, and the debt must have been used to either buy the property, to pay off purchase debt, or to repair/renovate the home. It does not apply to debt on second homes or income property, or on “cash out” refi debt.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.