Short Sellers Alert! The Mortgage Forgiveness Debt Relief Act is Soon to Expire
In the middle of a short sale or foreclosure deal? More than ever, you need a Realtor® and broker who can help you close these transactions quickly-- because as of 2013, changes in tax laws could hit you surprisingly hard.
In 2007, struggling homeowners scored a break when a special exemption was created to allow taxpayers to exclude from their income the amount of debt forgiven or canceled by their lenders in the case of a short sale or foreclosure. That exemption expires 12/31/2012.
Under the Mortgage Forgiveness Debt Relief Act of 2007, you can exclude from your taxable income the discharge of debt on your principal residence. That means in the case of a short-sale, you aren’t taxed on the difference between what you owe and the discounted price the home sells for. In a foreclosure, you don’t have to pay taxes on the canceled debt.
But by Jan 1, , all that changes. In a nutshell, if your lender cancels what you owe, the IRS requires that you report that debt as income-- because you get to “keep the money” now that your duty to repay it no longer exists.
The LA Times explains the coming change thus:
“So, if you owe $250,000 and your lender forgives $50,000 of that debt in a $200,000 refinancing, that $50,000 is considered income. If your combined federal and state marginal tax rate is 36%, you would owe $18,000 in taxes.”
Will Congress Extend the Mortgage Forgiveness Debt Relief Act?
As of now, talks regarding the fiscal cliff have been the focus of America’s leaders, with the media close behind. Clearly, these talks take priority, so we can’t say for sure whether this exemption will be reinstated or if that reinstatement will even come up for discussion before the year’s end. However, the Huffington Post reported in November that House Minority Leader Nancy Pelosi “believes that the mortgage relief provision will be on the table during the grand-bargain talks.” Apparently, extension of this tax provision has passed via bipartisan vote in the Senate, so is expected to be part of Congress' year-end negotiations—all in effort to “benefit the middle-class homeowners."
Can You Speed Things Up?
Meanwhile, if you are a seller in a short sale now, your best bet is to become as cooperative as possible given the timeline you have to get out of the transaction tax free. If there’s anything your lender, buyer, or Realtor ® has reasonably asked of you, and you can do this thing, you may be best served by doing it. Delaying an already protracted transaction will come back to haunt you, to the tune of additional income tax at both state and federal levels.
Anna Marie Erwert writes from both the renter and new buyer perspective, having (finally) achieved both statuses. She focuses on national real estate trends, specializing in the San Francisco Bay Area and Pacific Northwest. Follow Anna on Twitter: @AnnaMarieErwert