Extend the Mortgage Debt Relief Act – Will They or Won’t They?

April 30, 2012

There are currently somewhere around 11 million borrowers who are underwater in their mortgages. Some of those will refinance through the Harp 2.0 program (my guess is that it will be a small percentage). Some will keep paying and make the bank very happy (small percentage again). The larger chunk of these upside-down mortgages will either short sell their house or let it go in foreclosure.

That’s a lot of debt that will be forgiven if the bank agrees to the short sale or ultimately forecloses. The consequence to homeowners is that the bank issues a 1099C and it is reported to the IRS as debt forgiveness. The IRS in its glorious wisdom determined long ago that if debt is forgiven then you shouldn’t get the benefit of that forgiveness – you should pay tax on the debt forgiveness amount as if it were ordinary income!

Most people don’t quite understand the concept but let me assure you that it’s for real and the consequences can be dire. Historically there are 2 exceptions to this arcane law: Bankruptcy or Insolvency. My practice includes short sales, foreclosure and bankruptcy so I see a lot of debt forgiveness and help guide people through some complicated stuff almost everyday.

Let me explain these 2 exceptions: if you have debt forgiven and you file Bankruptcy you then don’t owe the IRS the debt forgiveness income tax. Also – if you have debt forgiven and at the time the debt is forgiven you are technically “insolvent” then the IRS doesn’t rub salt in the wound and you won’t be taxed. I would strongly suggest you have a good tax preparer help with this option since you really don’t want to get this one wrong.

That has historically been the 2 exceptions and real estate never goes down in value but guess what happened in 2007. Real estate was going down and the brilliant minds in Washington realized that there was going to be A LOT of debt forgiveness in the coming year so they passed a new law which created a 3rd exception to debt forgiveness income tax rules. It’s called the 2007 Mortgage Debt Relief Act and it gives relief to homeowners whose primary residence has debt forgiven because of a short sale or foreclosure (there are some limitations so make sure you talk to a lawyer and tax professional about your specific situation).

The problem is – it expires on December 31st of this year – 2012. The President is trying to get an extension but the gridlock in Washington is almost unbearable. Congress must somehow come together to get this law extended or there will be some real pain for some folks. Bankruptcy, insolvency or get the transaction concluded by the end of the year are the options people have right now.

Will this law get extended? I certainly hope so but I don’t have a crystal ball and every time I think some help from Washington is coming I get sadly disappointed. I think the chances are around 50/50 right now but its anyone’s guess.

If you have any questions or concerns about your own personal situation I would be happy to give you a FREE legal consultation. You can call me at 916.442.6400 or send me an email at tgreene@tedgreenelaw.com or go to my website www.upsidedownca.com.

Ted Greene

California Attorney and

licensed Real Estate Broker