THE FINE PRINT – December 2012 Issue
Debt Relief, Short Sales, Deficiencies, Oh My!
(think Lions, and Tigers and Bears ...)
Question: I am considering selling my home in a short sale,
but my Oregon
real estate broker has told me that I
may be subject to taxes because of the December 31st expiration of a federal
act providing relief to distressed homeowners from 1099 income. Is this true,
and if so, should I cancel my plans to sell my home.
Answer: Not necessarily. While the federal act providing
relief from taxes on the forgiven debt is currently set to expire, there are
still substantial benefits for considering a short sale rather than facing
foreclosure.
A bit of background. The federal act referred to is the Mortgage
Forgiveness Debt Relief Act (the “Act”).
The Act was intended to provide relief to distressed homeowners from
phantom income in the form of cancellation of indebtedness (the 1099
income). Such income may arise when a
short sale or a foreclosure occurs, the lender receives less than what is owed
on the loan (the deficiency) and the lender either agrees to forego collection
of the deficiency, or is barred by law from collecting the deficiency. This deficiency is then reported to the IRS
by the lender and treated as taxable income to the homeowner. Simple example: mortgage balance is $300,000,
home is sold for $200,00, and deficiency is $100,000. If homeowner does not have to ever pay back
this deficiency to the lender, it is treated as the 1099 income of $100,000,
and tax must be paid on it unless there is an applicable exclusion.
The Act provides an exclusion of
this 1099 income from taxation if certain qualifying criteria are met,
primarily being that the property was the primary residence of the homeowner
and that the debt was incurred in connection with the purchase or refinance or
improvement of the property.
Unfortunately the Act is set to
expire December 31st of this year, and while there are efforts
coming from multiple parties to get the Act extended (including a request of 41
state attorneys general), at this point in time there is no indicator that
Congress will act (one company tracking the status of the Act says there is
only a 9% chance of the Act being extended).
It should be emphasized, however, that even if the Act expires, it could
be resurrected in the next Congress in 2013.
Where does this leave the homeowner,
and where does this leave short sales?
All is not lost for the homeowner, and there are still legitimate reasons
for a homeowner closing a short sale.
Act May Be Revived and Insolvency
Exclusion
- Even if the Act
expires, the next Congress could provide retroactive relief.
- There may be other
exclusions from the 1099 income available to the homeowner in the form of the
insolvency exclusion. A tax professional should be consulted before a
determination is made that it applies, and the relief afforded. A helpful IRS pamphlet on the subject,
including a
Short Sales Still Valuable
- If there are both a
primary loan and a second loan against the property, a short sale may
still be the best way for a homeowner to negotiate a complete waiver of
any deficiency claims by both lenders, and without any contribution by the
homeowner. Even without any
ability to avoid the 1099 Income, the tax on the cancelled debt will still
be substantially less than the amount of the deficiency claims.
- It does provide the
homeowner control over your own destiny.
While lender still has to approve the terms of any short sale,
making a decision to proceed with a short sale and going through the
process does provide an element of control to the homeowner which does not
exist when the decision making is left entirely to the lender in the
foreclosure process.
Because of new legislation and new
case law in Oregon,
judicial foreclosures, as opposed to foreclosures by advertisement and sale,
have become the norm. If you own
investment property or the trust deed being foreclosed is not a “residential
trust deed” the lender may be able to obtain a judgment for the deficiency
after the sheriff’s sale, and attempt to collect against other assets you
own. A negotiated short sale can assist
in avoiding this result.
Decisions regarding the disposition
of one’s property has become far more complex.
A homeowner should work closely with the team of the real estate broker,
attorney and tax professional in making the final decisions regarding how best
to proceed.
David R.
Ambrose, CEO
Ambrose Law Group LLC
200 Buddha
Building
312 NW 10th Avenue
Portland, OR 97209
Direct Dial: 503.467.7237
Direct Fax: 503.467.7238
drambrose@ambroselaw.com
Disclaimer: this column does not constitute the
giving of legal advice, and your reading this column does not create an
attorney/client relationship. You are encouraged to consult a lawyer or
accountant should you have questions about how this information may be
applicable to your particular situation.
