Mortgage Forgiveness Debt Relief Act of 2007 Not Renewed And Its Ramifications

As we roll into 2014, the Mortgage Forgiveness Debt Relief Act of 2007 failed to be renewed.  I previously discussed this issue in a previous post.

What does this mean to you if you still have an active foreclosure ongoing?  From now on, if you receive a waiver of deficiency or sell your home through a short sale, you may be liable to the IRS for additional taxes.

Short Sale: In a short sale, you sell the house for less than you owe on the mortgage. The difference between what you owe on the mortgage and the short sale amount is the deficiency.  In most states, your lender can sue you for this amount. When selling short, make sure to address this issue. You must receive a short sale approval letter from your lender, specifically stating that the deficiency is waived.

Waiver of Deficiency:  This is similar in that the bank is forgiving any amount above what it can sell the house for if it wins the property at auction, or the amount above what a 3rd party purchases the home for at a foreclosure auction.  This amount is typically the difference between the price the home sells for and the fair market value of the property on the date of the sale.

How does this affect taxes?  In one of my previous examples I laid out the scenario where the homeowner loses their property to a final judgment and a foreclosure auction occurs.  The house sells for $50,000 at auction.  The fair market value of that home on that date was $175,000.  This leaves the homeowner with a $125,000 deficiency the bank gave the homeowner waiver of deficiency on.  This $125,000 under the Mortgage Forgiveness Debt Relief Act of 2007 was previously forgiven tax free.  Now, the IRS views this as income to the homeowner; $125,000 of additional income in that year.

Let’s say this homeowner makes $75,000 per year.  The homeowner now in 2014 must report $200,000 in income pushing the homeowner from a 25% tax bracket they would have been in up to a 33% tax bracket. This could lead to huge tax bills for that homeowner.

Please consider the ramifications of the Mortgage Forgiveness Debt Relief Act of 2007 failing to be renewed when considering accepting a deficiency waiver.  Under new Florida Statute, for cases filed after July 1, 2013, the bank only has 1 year to pursue you (sue you) for a deficiency judgment.  This may be worth the risk to many homeowners rather than accept a taxable wavier of deficiency.

Forty-two state and territorial attorneys general signed a letter recently which urges Congress to renew the law for another year, especially as the housing recovery seems to be losing steam with high interest rates and tighter mortgage standards looming in 2014.

An extension for 2014 is included in the Mortgage Forgiveness Tax Relief Act – S. 1187 and H.R. 2788 – both of which are stalled in committee.

There is still a chance that when Congress returns from holiday break next week.  An extension of the mortgage forgiveness tax break could be passed retroactively, just as it was was done last year.

Stay tuned for details….

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