Mortgage Debt Relief Act redux
Like a lot of you, I have been hoping that congress will move on extending this Act, so that any deficiencies on the short sale of the principal residences are simply rendered non-taxable for federal purposes.
Unlike many of you, I'd guess, I don't think the world of short sales will come to an end if it is not. Viz:
Under the tax code, you can exclude the cancelled debt as income to the extent you were insolvent just prior to the cancellation. To boot, the same form is used to report this as you would use for the cancellation that is not reported under the Mortgage Debt Forgiveness Act.
Now, it's not as good in the sense that you get to exclude it only to the extent that you were insolvent. So it is possible that the homeowner could pay some tax if they have a closer case. But in a quick review of the dozen short sales I have going right now, only 2 of them are that close. In most instances the client has very little in the way of assets.
I'm not an accountant, and had a headache for the entire semester I took Federal Income Tax Law in law school, so I suggest you discuss this with the nearest CPA you can find and back into a corner. Bring Tylenol. To prep, you can review the IRS' publication on cancellations of debt that have some pretty clear examples of how the 'Insolvency' is figured: http://www.irs.gov/pub/irs-pdf/p4681.pdf
Suffice it to say, this is definitely a fallback position, but in the event that the Mortgage Debt Relief Act is NOT extended, or is not acted on for a while, this is probably something that you should have in your bag of tools.
Happy Holidays!
P
Replies to This Discussion
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Permalink Reply by Wendy Rulnick on
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Harry - You are right. Sellers are reading the headlines only. Let's keep talking about this so people are not frightened.
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Patrick - This is absolutely true! Unfortunately, most of the media and many agents and potential sellers are frightened this will affect primary residence short sales. It shouldn't - so keep spreading the word. Ask your potential short sale sellers to check with their accountants to see if they pass the "insolvency" test.
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Permalink Reply by Patrick Smith on
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Absolutely. And this site is a great resource to help reach out to many of the professionals around the country who are involved in Short Sales, which is why I posted it here. I'd like to help calm the hysteria around the issue a bit. Yes, Harry is correct, any little thing can set off a chain reaction. And yes, it's harder for us to explain this insolvency exception than to simply say 'it's not taxable as gift income'; but if I've learned one thing in the past 5 years about short sales it is that not a single one of them is easy, and nobody who regularly does them expects them to be. Short sales are all simply various grades of difficulty. So, on this issue I'm hoping for the best, preparing for the worst, and somewhere in between am doing the extra work so that my clients have some glimpse of hope at the end of their long struggle.
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