(We are happy to have Kevin Hardin contribute this article. Kevin is an attorney and Director of Mortgage Mediation Group, which is a practice group at the law firm of McCarthy Law. Kevin is a 25 year veteran of the Mortgage and Real Estate industries and holds the following credentials: JD (Juris Doctorate) from Concord Law School and CMB (Certified Mortgage Banker). Kevin has spent the last 6 years assisting thousands of homeowners understand their legal and tax obligations on their mortgage as it relates to their underwater home or issues with a foreclosure. Click here for more info on the Mortgage Mediation Group.)
EXPIRATION OF THE MORTGAGE FORGIVENESS DEBT RELIEF ACT
Did it kill short sales? It should have had little impact on them. Expiration of The Mortgage Forgiveness Debt Relief Act (MDRA) has left questions in the minds of Arizona and California homeowners. Will homeowners owe a tax to the IRS if their lender forgives their mortgage debt in a foreclosure or short sale? While there are many articles on the topic, many miss the very important step in determining first, is that mortgage debt recourse or nonrecourse debt?
Before we go into the recourse nature of a mortgage in California or Arizona, lets talk about the Mortgage Forgiveness Debt Relief Act and Debt Cancellation. The IRS tells us “The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.” It had several extensions of the expiration date, but the current congress failed to act to extend this protection. You may be thinking that this is not a big deal as we have few short sales now. 2015 – 2018 may bring a new pressure on underwater homeowners.
What we were facing in 2007 was a foreclosure crisis as well as a negative equity crisis. These homes, going to foreclosure all over the country, were upside down and lenders were going to be issuing 1099’s that would create a major tax liability. The government needed to act. Most states in the US have full recourse or said differently, most states had no deficiency protection for homeowners in a short sale or foreclosure. Why does this matter?
If the mortgage has no protection from deficiency, then the expiration of the MDRA will have a dramatic impact on the homeowner’s decision. It may result in the requirement to file bankruptcy. But, if the mortgage has deficiency protection, the expiration of the MDRA does not have to be the end of the world. So why the confusion?
Back in 2007 many Arizona and California homeowners were not knowledgeable about their risk of deficiency if their home went to foreclosure, completed a short sale or received a principal reduction. Frankly most attorneys had little knowledge as well. So, the existence of the MDRA gave a layer of confidence, even if mostly not understood, that the homeowner will not face taxation.
We now have a clear understanding of deficiency risks and can make that analysis. An extensive memo was written by Paul Valentine, now with Jennings Strousse, and Kevin Hardin goes into great detail discussing how the IRS will calculate that cancellation debt tax. This memo created some great controversy in the market back in 2012 and 2013. Only later did a letter from the IRS, to California Senator Boxer, lend credibility to the argument that the forgiveness and the issuance of a 1099 post short sale would not create a cancellation of debt tax liability for many Arizona and California homeowners. In summary, with the expiration of The Mortgage Forgiveness Debt Relief Act should have little impact on many Arizona and California homeowner’s decisions to short sale their home or allow a home to go to foreclosure. Only a consultation will determine that.
If you are or someone you know are facing a decision and have questions related to foreclosure, deficiency, short sale etc, go to our appointment page to schedule or call us at 888-909-1030 to schedule a no cost consultation.