Superstorm Sandy was, to be sure, a national catastrophe. Looming even larger is the expiration of mortgage debt forgiven by a lender in a short sale, loan modification or foreclosure.
Set to go ‘adios' on December 31, the law requiring the nation's banks to forgive more mortgage debt means home owners will have to count mortgage relief from lenders as income on their federal tax returns. (There is no small amount of irony here because you’d think the lenders would forgive more mortgage debt as a prudent business practice that helps their bottom line and their shareholders but no, they’ve been mandated by the Feds to do it.)
Go figure… as of January 1, you will have to pay taxes on, say, a $100,000 reduction in principal owed on a loan, or a $20,000 write-off in the amount owed after a short sale. So the money you never ever saw (much less ever had) is now considered ‘income’ by the Feds.
The Good News: As it stands now, any mortgage debt forgiven by a lender in a short sale, loan modification or foreclosure is exempt from federal taxation and an extension of the tax exemption - established under the Mortgage Forgiveness Debt Relief Act of 2007 - is a strong possibility.
The Bad News: Congress may act this before Dec. 31 as part of the “Fiscal Cliff” package but that means the California Legislature cannot act until 2013 to conform state law since they’re not in session.
The Worse News: Given that Congress will have to wrestle with other serious money issues (See; Cliff, Fiscal), there is no guarantee the exemption will emerge as part of ‘the’ package. Now before we go running off willy-nilly, home owners should look into whether any of this applies to their situation, and consider their options.
(Trivia about ‘willy nilly’: Its’ application as in meaning ‘an undecided, haphazard manner' derives from the original meaning of nill, which was the opposite of will; a contraction in that is, will meant to want to do something, nill meant to want to avoid it. So, combining the willy - 'I am willing' and nilly - 'I am unwilling' expresses this contradictory idea.)
Best Bet: The House and Senate take up the exemption extension first thing in the 2013 session and since they have the power to do certain things, Congress can ‘backdate’ their actions to January 1.
Problemo: Given that short sales, on average, take two to three months to complete (some definitely faster than that time frame; others, not so much), the transactions being negotiated now are already bumping up against the Dec. 31 exemption cutoff… and what of those transactions that close in mid-January? Technically, they’re stuck paying taxes on this phantom income until something shakes loose at the federal level. This is a key as any benefit from the increased willingness of banks to commit to short sales could be wiped out if taxes start to be levied upon forgiven debt.
There are more than a few bills floating around Capitol Hill dealing with the extension and some of our local politicos are stepping up (Rep. Anna Eshoo is a co-sponsor of HR 4202, while Sen. Barbara Boxer is a co-sponsors of S2250).
We already know the result of what we’ll call “temporary inaction.” But what if partisan politics rears its finely preened head? Harsh as it sounds, people will walk away from these properties. Now that’s a Superstorm.