Some property owners facing the loss of their home to foreclosure will agree to sign away ownership to the lender hoping to “save” their credit and avoid bankruptcy (“deed-in-lieu”). These owners simply walk away with nothing to show for months or (sometimes) years of diligent compliance with the loan obligations. Most soon discover though that their credit worthiness has taken such a hit that they may never again qualify for a home loan. The bankruptcy that they sought to avoid usually follows. For owners who can no longer afford their mortgage payments, there are sometimes viable alternatives to filing bankruptcy or offering their lender a deed-in-lieu of foreclosure. One option that has become immensely popular is the “short sale.”
When lenders authorize a short sale on real estate, it means the lender is agreeing to accept less than the total amount due on the homeowner’s outstanding debt. Not all lenders will accept short sale proposals or will agree to a discounted payoff of the mortgage balance, but when compared to completing foreclosure and holding the property in inventory with potentially hundreds (or thousands) of other foreclosure properties, lenders are becoming much more motivated toward giving short sale proposals due consideration. Proceed with caution however. Short sales are no panacea (for the seller or his agent). There are significant consequences and some very real traps for the unwary.
Tax Relief for Borrowers
All Season Resort Realty is a real estate brokerage and while we are the best at selling your property in our neighborhoods, we are not tax or legal experts. When selling your property as a short-sale, we strongly suggest that you contact your attorney and/or accountant to discuss these matters as they relate to your unique situation.
On December 20, 2007, President Bush signed into law the Mortgage Forgiveness Debt Relief Act of 2007 (the “Act”). Under the Act, tax payers can “exclude” up to $2,000,000.00 of forgiven mortgage debt on the sale of their principal residences in the years 2007, 2008 or 2009. However, the Act is not all-encompassing. Some properties/mortgages will qualify, many will not.
Sellers will still receive a 1099-C form from their lender and will still have to file that form with their tax return together with a specific claim form and documentation of the fair market value of the home sold. Tax exclusion under the Act is limited. The debt forgiven must be from a primary mortgage on the tax payer’s principal residence. That status (“principal residence”) is determined based upon the amount of time the property was lived in over the preceding five years. Therefore, rental, investment and speculation properties sold by short sale will not be eligible. Additionally, the mortgage forgiveness must result from the loss of market value forcing a short sale in connection with a pending foreclosure. If the lender accepts, for example, services in lieu of payment for the forgiven debt, the Act does not apply.
The debt must be forgiven between January 1, 2007 and January 1, 2010. Last, the debt forgiveness must be on a mortgage for “acquisition indebtedness” which is money spent to buy the home, build home or make substantial improvements to it. Second, third or fourth, etc. mortgages/deeds of trust and home equity credit lines do not qualify under the Act.
Calculating the “benefits” of the Act can be challenging. Suppose you bought a house in Sun Valley ten years ago for $100,000.00 (as if!) and five years later the home had increased in value to $500,000.00. You did a cash-out refinance for $420,000.00, paid-off the balance of the original debt and spent the rest. Now the property values in Blaine County are plummeting (as if!) and you can only get $300,000.00 for the property so your lender agrees to a short sale, forgiving $110,000.00 of the re-finance loan amount.
Whether the Mortgage Forgiveness Debt Relief Act allows you to avoid paying income tax on the forgiven debt depends on what you did with the cash-out portion of the re-financed loan. If the money was used to buy a new Range Rover and season tickets to the Metropolitan Opera, you will owe taxes on the forgiven amount. If the money was used to remodel the home or add an addition, you will probably qualify for the exclusion from income tax on that money if you are able to prove the amount of the expenditures.
If instead of a cash-out refinance (“acquisition indebtedness”), you “stripped” equity from the property by getting a revolving line of credit secured by the home, none of the debt forgiven on that line of credit after a short sale is eligible to be treated as excluded income under the Act.
