We did not go over the “fiscal cliff” after all. As most know, a compromise bill was passed on various tax issues to avert the potentially devastating fiscal cliff requirements. Income tax rates, payroll taxes, and the estate tax were the most talked about portions of the compromise, but there are other components to the bill which may impact local community members. For example, part of the so called “Bush Tax Cuts” included the Mortgage Forgiveness Debt Relief Act. With the passage of the compromise, the Act is temporarily extended. Many Americans have never heard of this before, but the impact of this Act has already had a big impact on consumer finances.
What it Means for You
The IRS treats forgiven debt as taxable income. This act exempts forgiven debt from taxes. Before this act, if you are a homeowner who owes $400,000 on your home, but sells it for $250,000 in a short sale, you had to pay taxes on the $150,000 in forgiven debt because the IRS treated that as income. The Forgiveness Act exempted this debt from taxes. Thanks to the provisions of this Act, homeowners may take advantage of the short sale process and not get hit with a tax bill. The last thing a distressed homeowner needs is more taxes which could ultimately lead to personal bankruptcy.
Of course the whole concept of the “short sale” is foreign to many consumers in America. It can be a very complicated and lengthy process, but if you qualify according to your lender’s requirements, you may sell your home for less than you owe on it and still walk away without debt.
As we all learned from the last couple of years, the real estate market and associated loan industry is crucial to the nation’s financial stability. The short sale process helped to bring some positive momentum to the real estate market by helping the two key groups. It helped consumers to get out from under homes on which they owed much more than the homes are now worth without incurring additional debt and without going through the foreclosure process. This helps consumers to move on and become eligible to purchase new homes once they financially recover from the short sale.
At first glance this might seem like a bad deal for the lenders since they essentially allow people to renege on their debt obligations. However, many of the consumers who go through the short sale process are heading towards foreclosure. For lenders, the foreclosure process may take months or even years, and once the lender completes the foreclosure proceedings, it still has to try and sell the property and recoup the loss. The short sale allows the bank to get a fair market value for the home without spending the money required with foreclosure. The lender does not make money on a short sale, but it does not lose as much money on the transaction as it would with a foreclosure process and sale.
By exempting homeowners from paying taxes on forgiven debt, it encourages them to go ahead and short sell their homes. This generates more sales and takes more distressed properties off the market. This leads to a more stable market with fewer distressed properties while at the same time helping to increase prices. This is good for all consumers, not just those who are facing financial difficulties related to their mortgages.