HR 3648 provides income tax relief to foreclosed homeownersJohn Mazzarashort sales, deed in lieu of foreclosure, credit, debt forgiveness
What's positive about being foreclosed upon or selling a home
for less than is owed? Well, for most people, not much. Yes, there
is relief from an onerous mortgage loan and freedom to find housing
that is more affordable within an individual's budget, but not
everyone fully understands the lingering effects of a foreclosure
as it pertains to mortgage debt forgiveness. This applies to
foreclosures, short sales and a deed in lieu of foreclosure.
Foreclosure can be one of the most devastating things a
homeowner can face. At a minimum, the homeowner will end up with
damaged credit. Until recently, the tax laws further penalized
homeowners who were relieved of mortgage debt obligations with
additional taxation. Homeowners owed taxes on the amount of the
debt obligation from which they are relieved. For example, let's
look at a short sale. If a bank agreed to accept $200,000 as
payment in full to satisfy a mortgage where the homeowner owed
$250,000, the homeowner would owe taxes on $50,000. They were
relieved of repaying $50,000 in mortgage debt. When a homeowner is
relieved of debt, they are actually benefiting because they no
longer have the obligation to pay it back. Hence, the homeowner
must pay tax on this unrealized income, even if there was no direct
corresponding benefit such as equity proceeds from a sale. At the
same time, how is the homeowner, who has just lost everything,
going to be able to pay tax on the differential of the satisfied
mortgage obligation when they received no tangible proceeds from
As we have just seen, the amount of debt forgiveness is
considered income. All debt forgiveness, not just mortgage debt,
results in reportable, taxable income. Many people who've walked
away from their homes have found this out the hard way. Many found
out at the end of the year when they opened their mail and found
they had received a 1099-C. The 1099-C is the Internal Revenue
Service form that the creditor gives the debtor when they have
forgiveness of debt.
Today, there have been a record number of foreclosures. When
banks and lenders sell homes that they have gotten back during the
foreclosure process, they are less concerned about the bottom line
and more concerned about being rid of the collateral. This can
result in values spiraling downward in areas or communities where
foreclosures are high. Large numbers of foreclosures, like the ones
that are currently being experienced, are hurting our overall real
estate market valuations.
One solution to the problem has been to encourage those
homeowners in distress to work with the bank to sell the home while
they continue to occupy the property. This may result in a short
sale, whereby the bank agrees to accept less than is owed on the
outstanding mortgage. Together, the bank and homeowner work to sell
at the highest possible price, given the conditions of the
prevailing market. Working together allows the home to be
maintained and occupied during the course of the sale. Generally,
this is less costly to the lender and is one of the reasons why
they entertain short sales.
In general, short sales are less shocking to the market values
in comparison to a lender going through the foreclosure process and
then reselling the property as real estate owned. This should be
encouraged where possible.
Tax-wise, homeowners still receive a 1099-C. From a credit
report perspective, the lender usually wouldn't report a
foreclosure against the homeowner if they sell with a short sale. A
short sale, in that instance, would be beneficial to the seller's
credit and could be helpful when the seller becomes a buyer and
wants to obtain another mortgage in the future.
Minnesota has a unique situation regarding foreclosures. For
owner-occupied properties, there is a six-month right of redemption
from the date of the Sheriff's Sale. Because of the long redemption
period during which no payments are due, many in Minnesota are
opting to be foreclosed upon instead so they can live in their
homes for free. This occurs most often where preservation of the
homeowner's credit rating is no longer important to them.
To encourage lenders and homeowners to work together, the
government has just created a new law, HR 3648, or the Mortgage
Forgiveness Debt Relief Act of 2007, which was signed into law in
mid-December 2007. This law waives taxes for debts forgiven from
the beginning of 2007 to the end of 2009. This means no more
1099-C, at least during the specified timeframe.
Notice the implications? This means that homeowners and lenders
can work together to either sell or refinance the existing mortgage
debt, without having to recognize the taxes due on the amount
forgiven. It provides an incentive to protect a homeowner's credit
and work out an acceptable solution, such as a short sale. Income
taxes are taken out of the equation since there isn't anymore
inherent tax liability from mortgage forgiveness.
This should slow down the foreclosure crisis and allow values to
stabilize. It should also help ease the mortgage and real estate
crisis we are facing today.
John Mazzara, CMB is president of Venture Development Inc.
He may be reached at (952) 929-2577 or e-mail [email protected]