As reported December 17, 2014, by National Mortgage News:
The Senate approved a bill late Tuesday that would retroactively extend over 50 expiring tax provisions for one year, including the Mortgage Debt Relief Act, a 2007 law that shields distressed homeowners from paying taxes on any mortgage debt forgiven in a short sale.
The Senate approved the bill 76 to 16, which extends the provisions until Dec. 30 of 2014 (the one-year extension is retroactive). The House passed the bill 387 to 46 on Dec. 3. While the one-year extension provides thousands of homeowners who completed a short sale in 2014 with tax relief, many homeowners may miss out on the tax benefits as this appears to be the last extension.
At one point, House and Senate lawmakers were close to a deal on a two-year extension. But the White House objected because key business tax provisions were given permanent status while others affecting low- and moderate-income households would still have had to be extended each year. The one-year retroactive extension could be a set-back for the real estate recovery as lenders still have a large inventory of delinquent accounts.
The bill ensures underwater borrowers that sold their homes in a short sale in 2014 will not be penalized. The bill falls short, however, in that the extension is only good through the end of 2014.
In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act so that distressed borrowers would not be penalized for doing a short sale. Congress extended this tax relief in 2009 and 2012, but failed to pass a tax extender bill at the end of 2013.
Short sales have been declining over the past few years due to an improving economy, lower foreclosures and the uncertainty over the tax consequences of a short sale or deed in lieu transaction, where the homeowner simply signs over the deed to the house to the bank and vacates the property.
Mortgage Debt Relief In 2015
What is important to note, however, is in a recourse jurisdiction, such as Massachusetts, the homeowner still gets taxed on the forgiven debt in a deed in lieu of foreclosure transaction. In a foreclosure, the homeowner won’t incur tax liability, however, they will likely end up owing the lender the difference between what was owed on the loan and the net amount the lender receives following foreclosure, referred to as the deficiency amount, as the result of a post foreclosure lawsuit filed by the lender.
Absent the Debt Relief Act, distressed homeowners will have to qualify for one of the recognized exemptions, such as insolvency, in order to avoid paying taxes following a short sale or deed in lieu of foreclosure.
Insolvency Exception
Under the current US Tax Code, a homeowner can avoid tax liability following a short sale on their primary residence if they are “insolvent.” The IRS defines insolvent as “a taxpayer’s total liabilities exceeding his or her total assets.” The homeowner is allowed to use the total amount owed on the mortgage at the time of sale for purposes of calculating their total indebtedness. Consequently, most homeowners pursing a short sale qualify as insolvent because the amount of debt being forgiven by the lender usually exceeds the amount of their total assets.
All Short Sales Result in Tax Liability
Under the current US tax code, all short sales result in tax liability. The burden of proof lies with the taxpayer to show the IRS that he or she is exempt from paying taxes on the “cancellation of debt income.” In other words, the amount forgiven by the lender will automatically be taxed as ordinary income unless the taxpayer qualifies for one of the recognized tax exemptions.
The tax issues surrounding short sales are vital to the real estate recovery because 1 in 5 homeowners with a mortgage in the United States is “underwater.” It is important, therefore, to remind distressed homeowners and real estate professionals that all short sales result in tax liability regardless of the Mortgage Debt Relief Act Extension. The onus is always on the taxpayer to prove that they qualify for a tax exemption following a short sale.
What to do if you receive a 1099C following a short sale
Following a short sale, the homeowner will receive a Form 1099C from their lender releasing them from their obligation to repay their mortgage loan. Upon receipt of the Form 1099, the homeowner automatically incurs tax liability unless they file an IRS Form 982 with their subsequent tax returns.
The information provided in this article is for informational purposes only and is not intended, and should not be construed, as tax advice. All homeowners are encouraged to consult with a licensed tax professional prior to agreeing to a short sale.
If you are considering a Massachusetts short sale, and would like a free short sale consultation, please call Andrew Coppo to schedule a meeting or a telephone consultation at (617)264-0376.
Related Articles:
Fannie Mae Short Sale Guidelines
How To Qualify For A Short Sale: The Involuntary Hardship
Five Listing Agent Tips To Ensure Short Sale Approval
About the Author: Andrew Coppo of Greater Boston Short Sales, LLC (GBSS) is Massachusetts’ leading short sale negotiator. GBSS assists buyers, sellers, real estate agents and attorneys with getting their short sales closed. Contact us today if you are a homeowner facing foreclosure or a Realtor seeking assistance with a short sale transaction. GBSS is a MARS provider. Please read our disclaimer HERE.
