Dec
22

MORTGAGE FORGIVENESS ACT EXTENDED THROUGH END OF 2014

FINALLY!! Congress PASSED bill H.R. 5771 that amends the Internal Revenue Code to extend certain expiring tax provisions. In regard to short sales, the most important part of this bill extends the provisions of the Mortgage Forgiveness Act of 2007 through December 31, 2014 and made the change retroactive to December 31, 2013. The Bill states:

SEC. 102. EXTENSION OF EXCLUSION FROM GROSS INCOME OF DISCHARGE OF
QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS.
(a) In General.–Subparagraph (E) of section 108(a)(1) is amended
by striking “January 1, 2014” and inserting “January 1, 2015”.
(b) Effective Date.–The amendment made by this section shall apply
to indebtedness discharged after December 31, 2013.

So what does this mean to homeowners that sold their home in 2014 as a short sale? In a short sale, a homeowner is selling their property for less than what is owed to the mortgage company. When the mortgage company accepts less than the balance owed, the mortgage company can still expect the homeowner to pay the remaining balance OR forgive the balance owed by waiving the deficiency. In other words, if someone sells their home and nets $100,000 but owes the bank $150.000 on their mortgage, the bank would accept $100,000 at the sale of the home and then expect the homeowner to pay the remaining $50,000 OR waive the balance owed. When the bank forgives/waives the remaining balance, they typically send the homeowner a 1099C which is the IRS form reporting a cancellation of the debt. The IRS considers cancelled debt to be income. In the example of the home sale netting $100,000 with a $150,000 mortgage balance, the mortgage company that waived the balance owed would send a 1099C to the homeowner showing $50,000 of income to the homeowner since the mortgage company forgave $50,000 of debt. With the extension of this bill, the homeowner selling a principal residence would complete IRS Form 982 to declare the property as their “qualified principle residence” so they would NOT have to pay income tax on the forgiven debt.

What does this mean to homeowners selling a short sale in 2015? At this point, we would need to assume that a homeowner selling a short sale in 2015 will not have the advantage of excluding the 1099C as income for the qualified principle residence. However, if a homeowner is “insolvent” they also do not need to pay income tax on forgiven debt. The IRS publication 4681 states:

“Do not include a canceled debt in income to the extent that you were insolvent immediately before
the cancellation. You were insolvent immediately before the cancellation to the extent that
the total of all of your liabilities was more than the FMV (fair market value)of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include: The entire amount of recourse debts, The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt, and the amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the
property subject to the debt is forgiven”

Would a foreclosure be better than a short sale if I am not insolvent? NO! If you lose your home in a foreclosure, you receive a 1099A (abandonment) to show how much money the bank lost during the foreclosure and that is then taxable income to you. Usually, the loss to a bank is greater through a foreclosure than a short sale so the “income” to you would be greater. Also, the hit to your credit score is greater in a foreclosure than a short sale. As a general rule, your credit score takes a 100-150 point drop from on a short sale and a 250 point drop on a foreclosure. Typically after a short sale, your credit score can recover enough to purchase another home within 1-4 years. If your home goes to foreclosure, most mortgage companies will not offer you another loan until 7 years after your foreclosure.

In my opinion, we should be lobbying our politicians to extend this exemption for homeowners through at least 2016!

PLEASE TALK TO A TAX PROFESSIONAL REGARDING YOUR OWN PERSONAL TAX SITUATION SO YOU CAN MAKE THE APPROPRIATE DECISIONS FOR YOU.

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