If you’re a homeowner, savvy investor, Realtor, accountant, or in any way concerned about the US housing market, chances are you’ve heard of the Mortgage Forgiveness Debt Relief Act of 2007. Passed in (you guessed it) 2007, this Act is centered around one main idea, but broken into two separate scenarios.
The idea upon which this act is based is that traditionally in tax law if one is lent money and it is not repaid, then the recipient has realized a taxable gain (aka income) and must pay tax on it. Under this taxable gain idea, there are two scenarios into which one can fall:
1. Debt Forgiveness – When the outstanding balance on a mortgage is decreased due to some form of restructuring, such as a loan modification.
2. Debt Cancellation – When the entire outstanding balance on a mortgage is forgiven and the homeowner is no longer liable for the debt, such as the result of a foreclosure or a short sale.
The Mortgage Forgiveness Debt Relief Act of 2007 generally allows homeowners to exclude up to $2,000,000 of forgiven debt, as long as the forgiveness is directly related to a decrease in the home’s value or the homeowner’s financial condition.
The IRS has put many stipulations into place as the Act has evolved over the past six years, especially when it comes to the solvency (or lack thereof) of the homeowner and whether the property in question is a primary residence or an investment property; however that is neither here nor there since the basis for this article is the expiration of the Act. (If you do have questions about how the Act breaks down, please feel free to shoot me a message with your scenario)
So, it would seem, as Geoffrey Chaucer once said “All Good Things Must Come To An End” since The Mortgage Forgiveness Debt Act of 2007 is set to expire at the end of this year!
This means that whether your home is foreclosed on, you sell it short, or you modify it and receive a principle reduction, you will be stuck with a 1099 (in most cases) if it happens after December 31, 2013.
The chatter on the street is that the Act will not be extended (as it was last year), as the Federal government is making a strong push towards normalcy. This would also be inline with the other major stances the government has taken as of late, such as the tapering of the Federal Funds Rate (though we have yet to see this really happen), and the push to privatize Fannie & Freddie.
On one hand I understand the urgency to move housing market towards normalcy, however I do not believe that we are ready for them to take the training wheels off just yet. As I mentioned previously in my article about redefaulting, we are seeing homeowners who received modifications fall back into foreclosure at an alarming rate. Why? Because we have been treating the symptoms, and not the root issue.
In the past our government has essentially said “oh you can’t afford your property, here’s a temporary decrease in what your payment was” or “let me take $50,000 off the principle balance of your loan”, but they have never really addressed the job market. Therefore as modifications adjust, and mortgage payments begin to rise, homeowners are still in the same under-employed conditions that they were in when the received the modification initially.
Now I’m not cocksure enough to think that I have the answer to what is the greatest debacle in decades, but I do know that severing the relief that is afforded to homeowners under this Act would undermine the little stability that we currently have in the housing market.
Go ahead and take Fannie/Freddie private so that future loans are underwritten with more scrutiny, and feel free to taper interest rates as that will bring demand down to where it will be balanced with the lack of supply that we currently have, but if this Act is cut why would any homeowner choose to pursue any loss mitigation option other than foreclosure or bankruptcy? We will essentially be penalizing homeowners who are trying to act responsibly, and who are coming to us for help.
So what is the takeaway from all of this? What are homeowners who are underwater supposed to do with this information? Well, if it was me, I would short sell my property and get out of this mess before the end of the year; because who knows if you’ll be able to get out at all come 2014!
I look forward to your thoughts below, and feel free to call us at 888.550.4440 with any short sale help you may need (or visit our short sale calculator)!
p.s. here’s a little food for thought:
Property prices have been driven up in the housing market because of a lack of inventory, and because interest rates have been so low. Conversely, TONS homeowners have been refinancing their properties because interest rates are so low. So if homeowners are refinancing their properties at prices artificially driven up by low interest rates and a lack of inventory, what happens when interest rates are tapered and property values begin to drop due to weakened demand? Will we not have a new class of homeowners that are underwater because they refinanced at driven up prices only to have the market soften beneath them? #RefiCrash (If you doubt that the housing market is artificially driven up, here’s three perfect examples: the average listing price in the Hollywood Hills area, Woodland Hills, and North Hollywood, has increased in the past 12 months by approximately $250k, $100k, and $100k, respectively.)