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The Long Realty Short Sale Resource Center provides you helpful information on short sales, the short sale process and how to search for short sale properties. Articles are provided by the Long Realty Short Sale Resource Group, a collaboration of Long Realty agents and managers with an expansive knowledge of short sales.

Will time run out on short sale tax breaks?

October 25, 2012

A law relieving some homeowners of having to pay taxes on forgiven debt sunsets at the end of December 2012. How does that affect short sales?

Adapted from The Orange County Register By Marilyn Kalfus

Homeowners down on their luck and considering a short sale may now have to face yet another challenge in 2013.

A law exempting some from having to pay taxes on debt forgiven by the bank – the Mortgage Forgiveness Debt Relief Act and Debt Cancellation -- is set to expire at the end of this year.

There's optimism in the real estate industry that the act could be extended, but there's no guarantee, especially in a post-election lame-duck session. Others say the act would cost too much to extend in light of big budget deficits.

Either way, homeowners contemplating short sales as a way to get out of debt may want to seek financial advice because this issue gets really complicated. Short sale homeowners should be advised to see a knowledgeable tax expert, real estate attorney and/or bankruptcy attorney who can advise homeowners on exemptions for debt issues, such as insolvency.

As we know, short sales have been playing a big part in the Tucson housing market in recent years, far eclipsing foreclosures, and continues to be a very active segment of the local housing market.

How the debt relief act works

Most people know that in a short sale, the house is sold for less than the balance remaining on the mortgage, if the lender agrees.

When a bank lets a homeowner transact a short sale -- or forecloses or modifies a home loan -- the forgiven amount has traditionally been considered "income" to the homeowner and is reported to the Internal Revenue Service.

The Mortgage Forgiveness Debt Relief Act of 2007 exempts homeowners from having to pay tax on up to $2 million in qualified forgiven debt. Only cancelled debt used to buy, build or substantially improve a principal residence or refinance debt incurred for those purposes qualifies for the exclusion, the IRS says.

The National Association of Realtors and other proponents of the act have said that without it, the short sale market would largely freeze up, threatening the recovery and the economy, while troubled homeowners deciding to brave a short sale could again be mired in financial woes -- tax payments they can't afford.

Arizona is a "non-deficiency judgment” state when it comes to purchase money mortgages for most residential purchases. That means when a bank forecloses on a property, the lender is prohibited from pursuing the borrower for any unpaid balance (the deficiency). Under these circumstances, tax experts say, the homeowner typically does not pay taxes on the unpaid balance, which is not considered income, under current federal law.

The existing debt relief act may help them avoid paying taxes on the forgiven debt, explains Bradford L. Hall, a certified public accountant based in California.

Those who have refinanced (or taken cash out) to make improvements to their home – and have the documentation to prove it – would be covered by the act, he says. However, if they took the cash and spent it in other ways, the act would not apply.

Looking ahead

Many industry insiders and onlookers are debating whether an extension of the debt relief is likely. Some are betting that the law is not going to be extended in the face of the nation’s fiscal deficits.

However the pending expiration date is creating a greater sense of urgency among homeowners contemplating strategic defaults, voluntary foreclosures, deeds-in-lieu, and short sales.

There are no clear cut solutions, as each homeowner’s situation and tax scenario is different. But after January 1, 2013 if the debt relief act is not extended, say within the first quarter of the New Year, the IRS will be looking at these tax returns very closely, according to experts.

Lame Duck Congress

Long Realty will continue to monitor the situation within the current Congress in the coming weeks and provide additional information as soon as it becomes available. We don’t expect to learn much until after the national election on November 6, 2012.

Before using this service, consider the following information.


Long Realty Company is not associated with the government, and our service is not approved by the government or your lender. Even if you accept this offer and use our service, your lender may not agree to change your loan. If you stop paying your mortgage, you could lose your home and damage your credit rating.