Are Short Sales in Trouble?

Are Short Sales in Trouble?

A recent article by Diana Olick, a Real Estate reporter for CNBC, seems to suggest that Short Sales may be a thing of the past, or at least dwindling back into their pre-2006 numbers.  What's her reasoning, you might ask? For Olick, it all comes down to Taxes.

As you probably already know, the U.S. Congress passed the “Mortgage Forgiveness Debt Relief Act and Debt Cancellation” in 2007, in an effort to help troubled borrowers & advocate Short Sales.  One of the main ideas behind this legislation was to make Mortgage principle reductions tax exempt. So why does this matter, and how does it connect with Short Sales?  Well, successful Short Sales often result in debt forgiveness. Debt forgiveness is, more or less, income.  Income is taxable. 

For example, let's say "Dottie" is Short Selling her home.  Her lender has agreed to the Sale, and is taking a $50,000 loss on their Mortgage.  They have agreed to waive the remaining balance due on the loan, but must report the waiver to the IRS. The IRS interprets this 50k waiver as "phantom" income, which must be taxed. So, the IRS thinks Dottie just "made" $50,000 (She borrows & uses the 50k previously, but now she doesn't owe it anymore), and so Uncle Sam needs his cut.  But, as Rep. McDermott (D-WA) notes, "Collecting federal income tax on a relief intended for struggling homeowners is not only bad policy, but is simply wrong."

The passing of the 2007 Act allowed homeowners short selling their homes, to avoid paying Taxes on any forgiven mortgage debt.  Naturally, this helped Short Sales tremendously, as it limited the financial consequences associated with such a transaction. So what's the problem?  The MFDR act is expiring at the end of this year!! 

National Association of Realtors lobbyist Jamie Gregory says, "Realtors believe if the legislation is not extended, households who are already struggling to pay their mortgages will be further burdened with tens of thousands of dollars in additional taxes that they probably can't afford to pay because the IRS would count the cancelled debt as income."

If the MFDR act is not extended, any cancelled or forgiven mortgage debt would be taxed, regardless of the occupancy status of the property.  Since capital hill is currently entrenched in politics & the presidential election, many believe that such a "necessary" extension will go un-noticed.  

But, if the MFDR act is not extended, will it slow or even kill the Short Sale industry?  Slow, probably. Kill, no. "...getting a tax bill on forgiven debt can be another punch in the gut for families who are already facing financial hardship,” says David Stevens, CEO of the Mortgage Bankers Association.  While this may be painfully true, the fact remains that a % of an amount will always be less than the amount itself.  To put it another way, would you rather pay $10.00, or pay taxes on $10.00?  A Short Sale is still better than the alternative! 

**To read the CNBC article itself, go to http://www.cnbc.com/id/49214903**