Debt Forgiveness Act Extended – Short Sellers Breathe a Sigh of Relief

On January 1, 2013, as part of the so-called fiscal cliff negotiations, Congress passed an extension of the 2007 Mortgage Forgiveness Debt Relief Act. This extension of this act, which has saved homeowners more than $1 billion dollars in taxes, is great news for struggling homeowners nationwide. The extension is now only awaiting President Obama’s signature.

What is the Mortgage Forgiveness Debt Relief Act?

Under the Mortgage Forgiveness Debt Relief Act, debt forgiven in a short sale, foreclosure, or loan modification, is exempt from federal taxes on primary residences. For homeowners facing foreclosure, this exemption saves them from paying thousands, or even tens of thousands, in taxes on top of losing their homes. Now for another year, homeowners can take advantage of this exemption and avoid foreclosure without the fear of an impossible tax liability.

For instance, if somebody owes $250,000 on their mortgage and their lenders agree to a $200,000 short sale, $50,000 in debt is forgiven. Without the extension, any debt forgiven would be taxable, which, for underwater households, represents a financial burden.

The Mortgage Forgiveness Debt Relief Act was originally passed in 2007 to aid the millions of homeowners who suddenly found themselves in danger of losing their homes to foreclosure following the housing market crash.

Short Selling Your Hawaii Home in 2013

Rest easy if you’re trying to short sell your house – you won’t face a massive tax bill as a result if you complete the sale in 2013. And with banks recognizing the significance of short sales as an effective loss mitigation tool, they’re ramping up for business. Short sales will be the key loss mitigation tool used by mortgage servicers in 2013.

According to RealtyTrac data, short sales made up 22% of all residential short sales in the third quarter of 2012, a 17% year-over-year increase. A failure to reach an extension to this debt forgiveness law would have been deleterious to the nascent housing recovery.

At the end of the day, short sales are a vital component in clearing negative equity from the housing market. Although not totally benign, short sales tend to have less negative impact than foreclosure (which is probably the most destructive market clearing tool). Especially in Hawaii, where the judicial foreclosures are backed up in the Circuit Courts, the short sale option continues to be a viable vehicle for underwater homeowners with the extension of this act.

Additionally, NAR stated, “The exclusion from taxes for gains on the sale of a principal residence of up to $500,000 ($250,000 for individuals) remains in effect, so only home sellers whose income is $450,000 or above and the gain on the sale of their house is above $500,000 would pay taxes on the excess capital gains at the higher rate (with corresponding numbers for individual filers). For the vast majority of home sellers, there is no change.”

How Will The Extension Affect Kauai Real Estate?

On Kauai, the changes in legislation have made REO properties (bank-foreclosed homes) few and far between. Short Sales now make up the largest portion of distressed sales. In December 2012, distressed sales made up 23% of the transactions closed. Buyers looking to purchase these types of properties need to be pre-approved and ready to go as competition for these deals has increased in the last six months.

To find out more, download my Foreclosure Facts and Opportunities Toolkit.