Few people are aware that a law that has protected short-sale homeowners will expired as of December 31, 2013. Lambros Politis, Lead Counsel with Ark Law Group, PLLC quite eloquently described the details of this dilemma in his blog (http://www.arklawgroup.com/blog/how-to-avoid-paying-income-tax-on-your-forgiven-debt) Since congress passed the Mortgage Forgiveness Debt Relief Act in 2007 people have come to expect that a short-sale or even just walking away from their home and giving the keys back to the bank was the quickest and easiest way to get out from under water on their home.
The law has to do with the forgiveness of debt and how that was treated by the IRS. Prior to the passage of the law, if you sold your home for less than you owed on it, and the bank “forgave” a portion of the debt, the IRS treated that “forgiven” debt as income to you. Thus you had to pay taxes on money that you never saw, touched, or experienced. Let’s say you bought a house for $400,000 and still owed $300,000, but were only able to sell the house for $200,000 (which is a very realistic situation over the past few years). You would have to pay taxes on that $100,000 as income prior to the passage of the law. It was only because of the hue and cry and massive number of foreclosures and bankruptcies that Congress passed the law.
After passage, you could walk away from your over-priced, under-water house and retain a modicum of dignity and some of your credit by not having to declare bankruptcy. However, I think if the Mortgage Forgiveness Debt Relief Act is not renewed we will see many more people returning to the use of bankruptcy.
The expiration of this law may be one reason that many people think short-sales will go away or decline in numbers. It certainly appears it will be a contributor if the law is not renewed.
So the bottom line is that if you were thinking about a short-sale and can in any way accomplish the sale before the end of 2013, do it. If you were thinking of giving the keys to the bank and walking away, talk to an attorney and accountant now. Don’t wait. The prospects are bleak that Congress will extend the law because from what I have seen from Congress they haven’t made any move indicating they are going to extend this law.