By Lucy Carmel, THELAW.TV
If you’re trying to get out from under your mortgage by way of a short sale, time is running out.
People who undergo short sales in 2013 could face huge tax bills they could otherwise avoid now. The Mortgage Forgiveness Debt Relief Act that enables homeowners to waive tax obligations on home debt forgiveness is set to expire Dec. 31.
With the current law in effect, short sellers whose lenders waive unpaid mortgage debt don’t face a tax penalty. For example, a person who owes $300,000 on their home, sells the home for $150,000, and gets the other $150,000 waived by their lender can walk away.
Normal IRS rules stipulate that debt forgiveness is treated as ordinary income. So a homeowner in the same short-sale situation without the act in effect would have to pay taxes on the $150,000 waived debt.
“This is a tax bill for something you never received cash for,” says Todd B. Allen, Esq., attorney at Goede & Adamczyk, PLLC in Naples, Fla.“Most people in a short sale situation don’t have cash to pay that bill.”
This tax break is one of many on the fiscal-cliff chopping block. In a still precarious job and real estate market, the expiration of this bill could spell disaster for distressed homeowners.
“You’re talking about people who just lost their home to a short sale, and now they’re going to be chased by the IRS for taxes,” says Allen. “You’re not giving them a hand up by letting this statute expire; you’re kicking them while they’re down.”
Here’s what you can do to accelerate your loss mitigation strategy.
Call your mortgage lender
Contacting your bank to see what your options are as a distressed homeowner is step one. By law, lenders are required to disclose any government program you could qualify for. The Home Affordable Foreclosure Alternatives program, or HAFA, and the Home Affordable Modification Program, or HAMP, may be able to offer you further relief.
Contact an attorney
Short sales are notoriously lengthy. Anytime a lawyer is involved, however, the process moves more quickly. Attorneys deal with a different caliber of people within the bank than a homeowner would.
“If the bank realizes there’s counsel supporting the homeowner through this process, they’re going to be more attentive to what they’re doing,” says Allen.
Lawyers can help homeowners bypass frustrations such as the bank losing documents, and they can hold financial institutions accountable to federal guidelines.
Some attorneys and legal aids can help free of charge. And many attorneys will at least consult without cost initially, and they can point homeowners in the right direction.
With short sales, attorneys can also get paid by the bank when the property sells, so homeowners would pay little to zero out-of-pocket legal fees. In this scenario, the attorney fee is part of the closing cost for facilitating the sale.
For those who need to retain their own counsel, weigh the attorney fee versus the potential IRS bill should your short sale not close under the debt relief act.
“Spending $2,500 on an attorney to avoid owing taxes on $150,000 is money well spent,” says Allen.
Take advantage of a little-known law
Even if the debt forgiveness tax break expires, there’s a hidden gem in the IRS tax code that spell relief for distressed homeowners.
The “insolvency exception” waives taxes on forgiven debt. If a homeowner still has more debt than assets after forgiven mortgage debt, then the forgiven debt isn’t treated as taxable income.
Using the example of the $150,000 waived mortgage debt, if the homeowner’s liabilities still outweigh their assets after their home loan is forgiven, the $150,000 isn’t taxable.
“If someone’s using a short sale, it’s probably not the only debt they have,” says Allen. “They probably have student loans, credit cards and car payments.”
Given the time crunch of the potential expiration of the tax break and the uncertainty ahead, it makes sense to contact expert legal counsel to navigate and expedite a complex real estate transaction.