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Short sellers have one more year to escape taxable income on forgiven debt

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Underwater borrowers have one more year to swim to the surface and short sell their homes before facing income taxes on the forgiven debt.

The Mortgage Forgiveness Debt Relief Act (MFDRA), set to expire on Dec. 31, 2012, was extended to the end of 2013 as part of the "fiscal cliff" resolution.

“It is the only thing that I really cared about when it came to the ‘fiscal cliff’ because there was no sense in letting it expire,” said Shanna Welsh, attorney and real estate broker at Southern California Realty Law.

When someone short sells a home, the forgiven debt is considered income to the homeowner. With the MFDRA in place, that taxable income is forgiven.

“Say, for instance, the loan was $400,000 and the home resells for $300,000. The $100,000 bank loss would be taxed as ordinary income,” said Alan Nevin, principal at The London Group. “Worse, the loss would most probably push the homeowner into a higher tax bracket, thereby doubling the pain. For most homeowners that would result in the necessity to file a Chapter 7 since there is no way they would pay the taxes. Basically, their lives would be ruined.”

Welsh said she had several short sales in which the homeowners were desperate to close before the act’s expiration at the end of 2012, and none of those homeowners would have been able to close their short sales in time.

The extension was made on a federal level, Nevin said, and the state has yet to act on its extension. Senate Bill 30 (Calderon, D-Montebello) will extend the act in California for another year if it is passed, according to a release from the California Association of Realtors (CAR). The measure will be effective retroactive to Jan. 1, 2013 if passed.

“The MFDRA extension is of major importance, but it is only for one year. I strongly suspect that millions will take advantage of that ‘breather’ and place their homes on the market in 2013, not wanting to take a chance that the act will not be extended again,” Nevin said.

Nevin said he expects sales to increase as a result of more people able to take advantage of the declining prices resulting from the MFDRA.

“I believe this is necessary for the homeowners that are still in distress but want to avoid foreclosure, and a critical part of our housing recovery,” said Donna Sanfilippo, president of the San Diego Association of Realtors. “We are already seeing previous homeowners that experienced having a short sale two to five years ago reentering the housing market. Yes, I do believe it was a necessary component to our continued housing recovery in San Diego.”

RELATED ARTICLES:

Short sales outpacing sales of bank-owned homes

Short sales of homes surge as tax break nears end

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2 UserComments
John Taylor 10:07pm January 12, 2013

Good question..... Can you confirm this issue? Investment property/rental condo purchased solely for rental income....... Can short sale be done without taxable liability???? Please advise. ie: Orig. purchase condo, 2 BR - 2BA apt conversion @ $475 K w/ mortgage bal. @ $302 K...... Resale comps. now $220 K & hopeless recovery. Bad deal & need to short sale!!!

Chip 4:38pm January 10, 2013

Does MFDRA apply to investment property as well or only owner-occupied residences?