URGENT – IRS and FTB Update Regarding Short Sales

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The California Association of Realtors yesterday issued a press release stating that, as a result of recent rulings by the Internal Revenue Service and California Franchise Tax Board, mortgage debt forgiven in a California short sale is no longer taxable as income.

This is huge news, since the tax exemption for this income tax was scheduled to expire on December 31, 2013 when the Mortgage Debt Relief Act expired.  Without these rulings from IRS and FTB, California homeowners whose short sales did not close by year end were facing potentially enormous tax liability.

The IRS ruling was contained in a letter to Senator Barbara Boxer.  The FTB ruling was in a letter obtained the C.A.R. from Board of Equalization member George Runner.

The rationale for the rulings appears to be that debt forgiven in a short sale is not considered “recourse” debt under California law, thus exempting it from taxation.

The C.A.R. press release does not state whether this ruling also will apply to short sale of non-primary residences in California, or if it is limited to only certain types of mortgage debt.  I have requested my tax experts to review the actual letters and updated regulations to clarify these issues; I will provide that response immediately upon receipt.

At this point, it appears that similar protections will be extended to homeowners whose properties are foreclosed after December 31, 2013 where the debt forgiven was used to buy, build, or make substantial improvements to a primary residence.  It does not appear these protections will apply to “deed in lieu” transactions.

California homeowners with pending short sales may breathe a sigh of relief.  For these folks, it would appear that Christmas came a few weeks early this year.

URGENT: Homeowners Tax Exemption Extended Through 2013

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The 2007 Mortgage Debt Relief Act, which was scheduled to expire at midnight on December 31, 2012, has been extended for one year as a result of the “fiscal cliff” deal struck between Congress and the president.

The Senate included the extension as a part of the bill that passed at 2:00 a.m. on Tuesday morning.  After House Republicans failed to pass a separate bill modifying the Senate plan, that plan was presented for a full house vote late last night and passed 257-167.  President Obama has stated he will sign the bill.

EXTENDS TAX FORGIVENESS FOR MANY HOMEOWNERS WHO COMPLETE A SHORT SALE, FORECLOSURE, “DEED IN LIEU”  OR LOAN MODIFICATION IN 2013.

This is very important news for homeowners whose short sales and “deeds in lieu of foreclosure” had not been concluded by December 31st, and who were facing a substantial income tax bill if the exemption had expired and not been renewed.  It also will benefit many homeowners whose properties are foreclosed in 2013, as well as individuals who obtain a “principle reduction” loan modification on their home mortgages.

EXEMPTION DOES NOT COVER ALL FORGIVEN MORTGAGE DEBT

As I have previously explained, the tax exemption does not apply to all forgiven mortgage debt.  Specifically, the debt must have been on a primary home, and the debt must have been used to either buy the property, to pay off purchase debt, or to repair/renovate the home.  It does not apply to debt on second homes or income property, or on “cash out” refi debt.

STATUS OF CALIFORNIA’S SEPARATE TAX EXEMPTION NOT YET CLEAR

Keep in mind that the separate California tax exemption for mortgage debt relief also was scheduled to expire on December 31, 2012.  Whether that state exemption will be extended as a result of the federal extension is not yet known.  I will report further once that information becomes available.

I recommend you immediately contact your local representative if you feel the California tax exemption should also be extended.

CONSULT WITH A QUALIFIED ATTORNEY OR TAX ADVISER NOW TO DETERMINE IF YOU QUALIFY

For “underwater” homeowners that have been “sitting on the fence”, now is a good time to speak with a qualified real estate attorney or tax adviser to determine whether and to what extent you qualify for the extended tax exemption.  Keep in mind that it can take many months for a short sale, loan modification, “deed in lieu” or foreclosure to be completed.  For that reason, it’s important to get the process started as soon as possible.  That way you can implement your best strategy without having to worry about losing the tax exemption at the end of 2013.

 

Important HAFA Program Changes Announced

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The federal government’s flagship HAFA short sale program continues to evolve in hopes of more effectively addressing the needs of distressed homeowners for whom continued ownership is not longer a realistic option.  The most recent Supplemental Directive 12-02 was released on March 9, 2012; loan servicers are instructed to implement program changes effective immediately.  They include:

  • There are no longer any occupancy requirements for HAFA eligibility.
    Previously, HAFA required that the property be occupied as the borrower’s primary residence at some point within the prior 12 months.
  • The amount a servicer may authorize the settlement agent to pay from gross proceeds to subordinate mortgage holder(s) in exchange for a lien release and full release of borrower liability is increased from $6,000 to $8,500.
  • Borrower relocation incentives will be limited to HAFA short sales or Deed-in-Lieu transactions where the property is occupied by a borrower or a tenant at the time of the Short Sale Agreement or DIL Agreement and who will be required to vacate the property as a condition of the sale or DIL.
  • Borrowers may now elect to remain current on the loan during the term of the Short Sale Agreement or DIL Agreement.
  • Credit bureau reporting of HAFA transactions are amended as follows:
    • If the real estate is sold for less than the full balance owed and the deficiency balance is forgiven, report the following Base Segment fields as specified:  Account Status Code = 13 (Paid or closed account/zero balance) or 65 (Account paid in full/a foreclosure was started), as applicable.
  • The deadline for HAFA has been extended. A borrower now has until December 31, 2013 to submit a Short Sale Agreement or a written request for a consideration for a Short Sale Agreement to be eligible for HAFA.

The stated intention of the program updates is to expand the availability of HAFA’s benefits to more struggling homeowners.  Certainly, the increase in the amount of gross proceeds available to settle junior liens should help.  This has been an area of particular concern, most especially in California where the implementation in 2011 of SB 457 barred
lien holders from reserving collection rights following short sales or, alternatively, from conditioning short sale approval from additional seller contributions.  Of course, as with all previous program changes, the proof will be in the pudding.  Stay tuned….