Not Extending The Mortgage Forgiveness Debt Relief Act Through 2014 May Be A Blessing In Disguise

Mortgage Forgiveness Debt Relief Act Extension

702-487-0000 - Before I jump into examples as to why I think the expiration of the Mortgage Forgiveness Debt Relief Act may be a blessing in disguise, I think it's important we take a look at what it actually is and how it started. As the real estate market came crashing down many home owners started losing their homes to foreclosure or they had to attempt to negotiate the debt with their lien holders to get a loan modification or short sale.  The issue these home owners ran into was that in the eyes of the Internal Revenue Service, housing debt that is forgiven or written off is the same as income.  As you can imagine, getting hit with an extra $200,000 in taxable income could be just as detrimental to a home owners financial situation as the foreclosure itself.



For this reason, the United States Congress introduced the Mortgage Forgiveness Debt Relief Act September 25, 2007, which was then signed into law by President George W. Bush on December 20, 2007. The act offered relief to home owners who owed taxes on forgiven mortgage debt which was relieved from 2007 through 2009. As 2008 came to an end, the country's real estate market was still in shambles with no sign of recovery.  At that point, the Emergency Economic Stabilization Act of 2008 was passed extending relief an additional three years, covering debts discharged through the end of 2012.  Finally, on January 3, 2013 President Obama signed the American Taxpayer Relief Act which extended the deadline for the Mortgage Debt Relief Act to December 31, 2013. A current bill in Congress, the Tax Extenders Act of 2013 (s.1859), sponsored by Senator Harry Reid, would extend the Act through 2014. Experts think the passage of the bill is likely, however some are concerned that preparing for elections at the end of the year may interfere.

Although this issue has been around a long time, many people struggle to understand how you could be taxed on "income" you didn't receive. In an effort to better understand the IRS's logic, lets break down the "phantom income" created by forgiven debt into an example that's easier to wrap our head around.

For the purposes of this example, lets say you ask your friend to borrow $200.00 and they oblige with the understanding that you're going to pay them back. Two weeks later you go back to your friend and tell them you are unable to pay them $200.00 but, you could give them $100.00 if they would be willing to accept that as payment in full. If the friend agrees to accept $100.00 you have just "earned" $100.00 of income and according to the IRS, it is taxable.

For the sake of all of the home owners out there that are facing foreclosure, I personally hope the relief is extended through the end of 2014.  However, now that we have a good understand of the relief act, lets talk about why it may not be all that bad if it isn't extended.

The good news is the Mortgage Forgiveness Act isn't a home owners only option for tax relief.

The IRS offers an insolvency exclusion for canceled debts.

According to the insolvency exclusion in Publication 908: 

"You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. Determine your liabilities and their fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent."

With all of this information, the question becomes...

 What if the Mortgage Forgiveness Debt Relief Act is not extended?

• If it isn't extended, anyone who isn't truly facing a financial hardship likely would not consider doing a short sale or a loan modification.  Buying and bailing or strategic default simply wouldn't be an option because the tax implications would be too great to offset the "gain." We are experiencing this in Las Vegas right now. The number of new short sales coming on the market is extremely low which I believe is due in part to the uncertainty around the seller's tax implications. 

• Applications for assistance would be fewer in quantity and only from home owners that legitimately need help. Due to the reduction in requests for assistance, loss mitigation departments servicing the loans would not be as overwhelmed resulting in quicker turn times and perhaps the ability to look at each individuals situation. 

• One may also assume home values would increase due to the higher number of traditional equity transactions which typically close at a higher price than distressed sales resulting in a faster, healthier recovery.

• Those looking to purchase a home would have a better experience simply because inventory would consist of more equity sales and the short sales that are on the market would have a higher likelihood of closing.

In summary: It would be great if the Mortgage Forgiveness Debt Relief Act is extended through the end of 2014 however, it isn't the end of the world if it isn't.

To schedule a private consultation with The Jamie Cox Group regarding your specific situation contact us at 702-487-0000

I am not an attorney or certified tax professional. The contents of this post are strictly my opinion based on my experience and involvement in hundreds of short sales as a real estate agent in Las Vegas.