Of the 180 readers who participated in our recent poll, 78% (140 voters) supported extending the Mortgage Forgiveness Debt Relief Act (the Act) which is currently set to expire at the end of 2012.

Currently the Act allows relief from discharge-of-indebtedness income resulting from shortsales on homes encumbered by an underwater mortgage. Losing this Act would not hamper Californians with nonrecourse loans, those purchase-assist loans funding acquisition of one-to-four unit residential property, one unit being occupied by the buyer as his principal residence. A property owner is not personally liable for a nonrecourse loan. [26 CFR §1.1001-2(a)]

For holders of non-purchase money loans (refinances, equity loans/HELOCs), it’s a slightly different story. To clarify a point which some commenters asked about: on January 1, 2011,California expanded antideficiency protection to discharge-of-indebtedness income from a first trust deed on a shortsale —for both purchase money and nonpurchase money loans, i.e. refis.

Then, in July 2011, the state further expanded antideficiency protection to include discharge of indebtedness income from any lien on a shortsale, provided a shortsale agreement exists between the homeowner and all participating lenders. (Obtaining that shortsale agreement is another story…)

Related articles:

Extend and pretend data for home loan mods

Antideficiency bars first trust deed recovery on shortsales of one-to-four residential units

Antideficiency protection extended to second trust deed discounts

California lenders have lawyers, and the lawyers all understand this information. With these additional California protections in place (if homeowners are lucky enough to wrestle consent from lenders), shortsales in the state will continue to crawl along for most of California’s insolvent homeowners, a constant balancing act between what lenders think they will be able to get on a shortsale, and their reticence to clear out the bad paper on their books and declare their losses.

Related article:

Shortsale or foreclosure? The naked truth for underwater homeowners

As the rational alternative to a shortsale or bankruptcy, strategic defaults will increase. Why should families continue to pour money into a black-hole asset without good reason to invest further money in a financially unattractive home?

To cast your vote and read more about the Mortgage Forgiveness Debt Relief Act which may not be extended at the end of this year, see the March 2012 first tuesday article, Tax avoidance for discounted shortpays set to expire – are Californians in trouble?