Prior to 2007 homeowners who had a short sale or foreclosure were subject to pay income taxes on any amount of forgiven debt. So let’s say a homeowner in 2006 had a mortgage of $400,000 and decided to sale as a short sale for $200,000, that homeowner would have had income of approximately $200,000 according to the IRS. Assuming this put that homeowner in the 25% tax bracket, this homeowner would owe an additional $50,000 taxes to the US government. Keep in mind, perhaps none of this money went into the pocket of the homeowner, it was simply forgiven debt. The same would be true for a bank foreclosure.
Back in 2007 the US government signed into law the Mortgage Relief Act which provided homeowners who used their home as a primary residence relief up to $2 million for married couples and $1 million for individuals from any shortage being treated as income by the IRS. In the previous example above, the $200,000 would be free from being treated as income as long as it was their primary residence. The lender must formally forgive the loan.
The US government is giving homeowners until December 31, 2012 to complete a short sale or foreclosure. Starting January 1, 2013 any debt forgiven, even on a primary residence, will be treated as income by the IRS and subject to taxes. Do click here to read more about all that is related to the topic so that you can save your money while there is still time.
A homeowner doesn’t always control when the bank will take back a home or when the bank will complete the foreclosure transaction, so they cannot guarantee they’ll make the December 31 deadline.
A distressed homeowner does control to a greater extent the execution and timing of a short sale. While there is no guarantee the bank will agree to a short sale, or that the buyer will wait around long enough for the lender to agree, it is generally known the seller has more control over their fate in a short sale than a foreclosure.
Time is running out for many sellers as we have 11 ½ months to complete the short sale. Some short sales go smooth, and others are a bit trickier. Sometimes we have to sell it 2 or 3 times if buyers walk. The bank may respond right away, or it could take several months for the banks to complete their analysis depending on who the lender is, whether there is a 2nd mortgage or equity line involved, and especially if mortgage insurance is involved.
Most people just think the banks are slow, which is true. However, the process can be more complicated as the 1st lender may be due money back on certain losses by a private mortgage insurance company. This takes time for all to evaluate, and it must go in steps.
Some loans are guaranteed by FNMA or Freddie Mac, and there are governmental programs in place the lender must follow. A popular program you may have heard of is HAFA (Home Affordable Foreclsoures Alternative) Program. If the home falls under this program, certain procedures and timelines must be followed. Sometimes it takes time just to see if the loans qualify for this program. There are other programs as well.
This is why a seller should decide soon if they may need to sell their home due to hardship. The decision today could save thousands in taxes for years to come. Waiting too long could cost a seller big time.
A bankruptcy may be a solution to avoid such taxation after 2012, so we wouldn’t be surprised to see bankruptcies rise next year from sellers who miss this deadline.
The good news is lenders have beefed up their short sale department staffs the last few years and are equipped to handle more sales today than they were 5 years ago. We’ve had much success completing short sales, although the buyer must be educated that the bank will take some time, and they may counter the accepted price with the seller a bit higher.
No short sale is complete until the lender(s) sign off and everybody agrees to the terms. Short sales are a way to bring otherwise underwater overpriced property to the market at today’s lower prices. Education is the key for everyone involved. The agents involved, both buyer agent and seller agent must be competent in handling complex short sale transactions as both buyer and seller must be educated about the process.
Sales are already heating up this season, so 2012 could be an interesting ride. We’ll keep you posted on news affecting buyers and sellers in the SW Florida real estate market.