Nationwide, the housing market has rebounded, and fewer homes are under water. Nevertheless, over 3 million home owners are seriously behind on loan payments and over one million are in the foreclosure process. Of the 3 million delinquent, many would benefit from a short sale, a process which has been beneficial to many home owners, as well as the overall real estate market, for the past 7 years.
However, an important tax exemption established by Congress in 2007 has expired. Most believed it would be extended. As of now, it has not been. The exemption involves a “tax break” which was created by the Federal Government which allowed a short sale without the home owner being taxed on the difference between sales price and the amount they owed. As of January 1, 2014, borrowers closing a home through a short sale must declare the difference as “income”. The same rule will apply for any “mortgage forgiveness” refinances.
With this rule now in place, millions of home owners are likely to be faced with this lose-lose proposition: If they cannot afford to keep paying the mortgage on their current house, they likely will not have the cash to bring to the table in a loss situation; if they try to relieve themselves of some of this burden via a short sale, they will be taxed and likely unable to pay the tax amount.
For those who think banks will benefit from this, think again. Short sales have been a major force in clearing the deck, so to speak, in distressed real estate. With the short sale option off the table, more borrowers will simply allow foreclosure, which will increase liquidation times and less recovery of loss by investors. The foreclosure process is also driven by state laws, and the cumbersome process in many states will leave distressed properties in an unattended state for long periods of time.
Forcing short sellers to declare the “forgiven” amount as income effectively shuts down the short sale market. This will toss many more homes into foreclosure, at a time when foreclosures have declined dramatically and the overall market is rebounding sharply. This is not in anyone’s best interests. it is time for Congress to act.