HR 3648 provides income tax relief to foreclosed homeowners – NMP Skip to main content

HR 3648 provides income tax relief to foreclosed homeowners

National Mortgage Professional
Mar 24, 2014

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 the sale?

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].

Published
Mar 24, 2014