As interest rates begin, ever so slowly, to rise, the Federal Reserve has acknowledged that the country has finally, after seven years, climbed out of the recession of 2008-9. That acknowledgement will have an impact on all of the economy, but especially on real estate.
In 2007, Congress realized that homeowners needed relief from the tax implications of the debt forgiveness after short sales, deeds in lieu of foreclosure and foreclosures. They passed the Mortgage Debt Forgiveness Act which has been extended from year to year ever since.
When a homeowner takes on a mortgage they receive money – even if that money doesn’t go directly into their pockets but goes to pay for a piece of property, pay off a prior mortgage, pays for repairs or improvements on the property or goes to pay other obligations. The IRS does not consider that income unless it is not paid back, such as through a short sale, deed in lieu of foreclosure or foreclosure (there is an exception if the homeowner declares bankruptcy – no income is realized in that event).
The Mortgage Debt Forgiveness Act provides that the income realized on a homeowner’s residence is forgiven if the homeowner does not pay back the borrowed money due to a short sale or other loss mitigation efforts. Therefore, there is no tax implication on the forgiveness of the mortgage debt.
In the last Omnibus Bill, Congress included an extension of the Mortgage Forgiveness Debt Act until December 31, 2016. That means that residences short sold and closed before the end of 2016 will not incur tax obligations when the mortgage is not fully paid when settled with the lender.
If you are underwater on your mortgage and considering your options, this may be the last year to use loss mitigation options before those options cause you to incur tax implications. As the Federal Reserve has indicated that they believe that the Recession has ended, Congress may well follow suit at the end of this year and declare that homeowners no longer need debt relief if they need loss mitigation alternatives for their property.
If you are considering your options regarding your property, now would be a good time to talk to your real estate professionals. As most options take months to finalize, knowing what your options are, and what time frames will be needed to conclude negotiations, can mean a savings of tens of thousands of dollars of tax liability.