Do you support renewing the Mortgage Forgiveness Debt Relief Act?
- Yes (80%, 207 Votes)
- No (20%, 52 Votes)
Total Voters: 259
Is the end nigh for shortsales?
In response to the housing crisis, the federal Mortgage Forgiveness Debt Relief Act (the Act) expanded tax relief for lender discounts on shortsales to cover both recourse and nonrecourse mortgages. If the Act is allowed to expire at the end of 2012, many California homeowners with underwater homes will lose their ability to avoid income taxes on the resulting discharge-of-indebtedness income.
In the fourth quarter of 2011 there were over two million mortgages with negative equity in California. Thus, about a third of all California homeowners were encumbered by a mortgage amount exceeding the value of their home, according to Corelogic. With shortsale negotiations still taking in excess of five months, homeowners looking to escape from their underwater prisons had better get a move on or find out whether they are covered by some other regulation before the Act expires.
Related articles:
Discharge of taxation on indebtedness (principal reductions)
FARM Letter: Shortsale and foreclosure sale discounts: common tax reporting mistakes
With an annual price tag of $1.35 billion in lost tax revenue, Congressional members of the austerity camp counting down to Re-Election Day will fight hard to keep the Act from being renewed. How else to better prove they’re tough on homeowners who “unfairly” receive forgiveness for their housing debts while others continue to pay?
first tuesday take: Say Congress does forget what their institution is about (likely) and allows the Act to expire. Fortunately, dear reader, there is recourse available for most shortsale-prone Californians – or should we say nonrecourse?
The back-up escape route to the Act’s expiration lies in federal regulations. To understand the regulations, a review of California anti-deficiency statutes is needed. The anti-deficiency statutes bar a mortgage lender from collecting any market-driven loss on a purchase-assist loan encumbering a one-to-four unit principal residence. Such a home loan is considered a nonrecourse loan since the buyer is never personally liable for the loan, and the lender’s sole source of recovery is the home securing the purchase-assist loan. [Calif. Code of Civil Procedure §580b]
A homeowner with a nonrecourse loan who participates in a shortsale, foreclosure or principal reduction incurs no discharge-of-indebtedness income since any windfall on nonrecourse loans in a shortsale is not reported as taxable income. This regulation is not contingent on the Act, and in fact has been around since the 1930s. [26 CFR §1.1001-2(a); see Tax Benefits of Ownership, Chapter 15: Short Payoffs on loans in foreclosure.]
If the Act is not renewed, an increase in strategic defaults is the likely result, especially among homeowners with recourse mortgages not covered by the Internal Revenue Service (IRS) regulations for nonrecourse loan shortpay on a shortsale. Underwater homeowners with recourse loans will simply skip the rigmarole of wrangling with a lender for shortsale approval and abandon their attempt to “do good” by selling the property to help satisfy the lender.
Instead, they will be compelled to simply walk away from their properties, properly seeing no benefit for being taxed on the “gain” from the debt forgiven in a shortsale.
Re: “Distressed homeowners may lose hefty tax break tied to mortgage modifications” from the Washington Post
Update: for clarification on the connection between strategic default and the Act, see The votes are in: extend the Mortgage Forgiveness Debt Relief Act
I hope the government does NOT extend the mortgage forgiveness act and here is why. Short sales are ruining the real estate market because of the fact the short sale lenders do not see all the offers made on the property. Over and over, I see sellers accepting offers way below market value and the short sale lenders approving the sale when there were 5 other offers for much more money on the property.
Why does this happen? Mainly because the sellers get nothing from the sale and there is no incentive to take the highest offer. By submitting low offers they can often extend the amount of time they get to stay in the house for free, hoping the short sale lender will reject the offer, then starting the process over with a new one. Another thing I see often are concessions outside of escrow made by buyers so the seller will put their offer through and not an offer for more money.
Foreclosures are different. The lender is the seller and sees all the offers so true market value is achieved from the sale.
Additionally, people who need, for financial reasons, to walk away from their houses don’t have to pay taxes anyway if they qualify as insolvent (meaning their total assets are less than their total debts on the day before the short sale completes). I think enough time has been given to those who don’t qualify as insolvent to have done their strategic short sales and it is now time to get back to normal.
And finally, lthough no one seems to mention it, the end of the mortgage forgiveness act is the reason there are so few houses on the market. That was my prediction a year ago and why, in NorCal, I am seeing houses selling consistently for way above market value.
100% agree with Michael Grant, Mark Bradley, and D. Mathews. I am disgusted with people that mooch off the rest of the honest taxpayers, and used their homes to buy things they didn’t need. So now, because of their irresponsible actions, they may also get to have principal reductions of their mortgages as a reward for being dead beats.
I do have sympathy for those that lost their jobs and subsequently had their homes foreclosed, but I have seen too many people gaming the system, (doing strategic foreclosures) and it irritates the heck out of me.
Barney Frank and the libtards that required the banks to lend to those that clearly couldn’t afford a home are primarily to blame.
It’s time to stop all of these programs which have done absolutely nothing to help the housing market. It’s truly sad when people lose their homes because of legitimate reasons. But these programs where designed mostly for people who couldn’t afford the home in the first place. That’s why re defaults are somewhere around 50%. Let the market do what it needs to do. Sooner or later, they’re going to run out of band aids. Of course the unemployment rate will skyrocket, when all of these quasi government employees hit the bread line. You can’t fix stupid – Sorry! It’s the only thing that fits the situation.
Let the market correct!
A refinance mortgage is not non-recourse, and therefore not saved by that escape hatch. However, at least until the end of the year, the portion of it used to refinance a purchase loan is exempt from the debt forgiveness tax. My experience is that a very large proportion of distressed mortgages are refinance loans, the ones that explode in your face. So, a lot of homeowners are getting limited help from the exemption already.
Also, though less significant, what happens to California debt forgiveness income tax? The non-recourse escape hatch, according to the article, is a federal phenomenon.
By the way, I don’t understand the logic about everybody’s going to opt for strategic default (intentional foreclosure) versus short selling. The debt forgiveness exemption applies to both, so its disappearance makes the consequence of either more onerous, but with little relative difference. Somebody choosing to short sell now, probably would choose to short sell then, unless they’re just plain pissed (can’t blame them).
A parting question: Can debt forgiveness income tax be discharged in bankruptcy? One more: Any difference between California and federal tax? Oh, and just one more question: How the f**k does the IRS expect to get paid?
Yes, I really like this program. It will help our Economy and our American people out of this tough time of life.
@Rick Cesario: That portion of the new loan obtained at refinance that exceeds your purchase price is not non-recourse, the banks can claim it and the taxman tax it, but both need to be masters at the art of squeezing blood out of a foreclosed turnip.
The mortgage debt forgiveness act needs to be extended. The economy is fragile. Also, the lenders do not operate on an even playing field. In that, loan mods, prinicpal reductions etc. are not available for everyone.
A “purchase assist” loan is a no recourse loan.
What about a re-fi? I would venture that a LARGE percentage of people default had re-fi’d somewhere in the course of their ownership.
Anyone have the answer?
They borrowed the money…They owe the money! What about all those who had to pay this tax in the past when they lost their home? Should we go back and make them whole by requiring the IRS give the money back? No one put a gun to the borrower’s head and forced them to take out a loan. Buying a home has no guaranties. It is no different than playing the stock market. If the borrower borrowed the money from their parents or grand parents would they screw them like they are screwing the bank? It’s no different. They borrowed the money and the bank loaned the money in good faith. The entitlement band wagon must go!