Will the Debt Forgiveness Act Expire This Year?

With the Mortgage Debt Forgiveness Act set to expire at the end of this, a storm cloud may be on the horizon.

For those of you who are unfamiliar with the legislation, congratulations! You probably have not had to experience the financial hardship of being upside down on your home. To those homeowners who have been through a short sale or a foreclosure beginning in 2007 to present day, this law has provided some much needed financial relief.

Will Short Sales be Subject to Tax?

For instance, if you purchased your primary residence for $600,000 and then completed a successful short sale where your home was sold for $450,000, it results in a difference of $150,000. Since it was “forgiven” so to speak and it was not paid, our friends at the IRS view this as income. And everyone knows how you report income, you pay tax on it. So a double edge sword in which you receive both ends, a kick you when you’re down scenario. Lose your investment in your home and pay tax on the disparity between the purchase and final sales price. The courts call this double jeopardy when it applies to murder. When it applies to real estate we call it tax law.

Storm Clouds Loom

A precursor to foreclosure is a loan modification. With foreclosure becoming more and more of an arbitrary subjective process, loan modifications have become more commonplace. Far from ubiquitous, but more frequent. Read through a loan modification agreement. The agreements I have heard about are a negatively amortized mortgage in reverse. If your house payment was $2500 and the loan modification calls for a new payment of $1000, the difference of $1500 is just tacked onto the end of the mortgage. It doesn’t go away, it just kicks the can down the road until the eventual day of reckoning. Very much like the California budget process.

Implied in the loan modification is an eventual short sale, one day, sooner or later. No longer treading water, but sinking deeper. But it is an air tank allowing you to breathe until you decide its time to move on.

Preparing for the Big One?

With increasing loan modifications and a continual prolonging of the short sale process are we preparing for financial Armageddon? With the end of the Debt Forgiveness Act in sight, would you be better off selling your home this year as opposed to keeping it for an indefinite period of time and possibly facing a huge tax bill down the road?

At least if you were to sell this year you’re aware of you tax implications or lack thereof. Next year, it could be anybody’s guess as to what will happen. You would most definitely think the law would be extended, but these are crazy times. Who knows, it could possibly be given a 60-day extension just like the payroll tax cut.

This is not intended to be considered tax and legal advice. Please consult with the appropriate professional (Tax Attorney, CPA, etc) on your specific situation.