WEST PALM BEACH, Fla. – Attorneys are predicting a rash of bankruptcies and a prolonged foreclosure morass if an expired tax exemption for homeowners isn’t restored by Congress.
The Mortgage Debt Relief Act, which expired Jan. 1, allowed borrowers whose banks forgave unpaid loan amounts from a short sale, foreclosure or principal reduction to not count that money as income on their tax returns.
It’s a measure that can save a homeowner tens of thousands of dollars in taxes on so-called 'phantom income' earned when the debt is absolved. Without it, a homeowner forgiven $150,000 in debt could end up owing the IRS $42,000 in taxes, depending on the tax bracket.
“People are asking me why should they cooperate with the bank on a short sale when there is no more benefit,” said Adam Seligman, an attorney who focuses on real estate with the Ward Damon law firm in West Palm Beach. “Most people want to work with the bank, but if they do that and still get tagged with a $50,000 tax bill, what’s the point?”
Instead of cooperating, Seligman said homeowners may decide to ride out a foreclosure – socking away money while living in the house for free – and then file for bankruptcy right before the foreclosure auction to delay having to move even longer.
Another strategy is to refuse the debt waiver when it is offered, pushing the overwhelmed lender to pursue the money instead of having the IRS come for unpaid taxes on it.
While banks have largely chosen not to chase after borrowers, “the IRS doesn’t go away,” said Jack McCabe, chief executive of McCabe Consulting and Research in Deerfield Beach, Fla.
'I think putting this kind of tax responsibility on people who can’t afford their mortgage already will kill short sales, and for some, bankruptcy will be their only alternative,' McCabe said.
Homeowners have benefitted from the Mortgage Debt Relief Act for six years and there is a chance Congress will approve an extension that applies retroactively to Jan. 1.
John Sebree, senior vice president of public policy with Florida Realtors, is optimistic. He said holidays and winter storms have delayed bill discussions and the tax exemption may not see a vote until late March or early April.
Sebree noted that 55 expiring provisions are also in line for renewal.
“Every interest group from NASCAR to teachers to Puerto Rican rum is impacted so there is a lot of pressure to do these extenders ASAP,” he said.
A majority of the nation’s attorneys general are also pressing for a renewal. A December letter signed by 40 attorneys general, including Florida’s Pam Bondi, called the housing market fragile, and said the tax exemption was “vital to our continued recovery and to our citizens who have already lost so much.”
At least two bills are in play to extend the tax credit. A Senate bill sponsored by Michigan Democrat Debbie Stabenow has 19 co-sponsors. New York Republican Tom Reed is sponsoring a House bill that has the support of 70 members – 38 Democrats and 32 Republicans – who signed on as co-sponsors.
Both bills are in committee.
“The federal lack of action is producing very negative consequences,” said foreclosure defense attorney Matt Weidner. “I can no longer advise my clients to accept a waiver of deficiency because you are potentially obligating them to an IRS problem.”
And until the exemption is renewed, homeowners are in a limbo as to how to handle their short sales.
“A lot of people are concerned,” Seligman said. “Some are still closing sales hoping it will work out, but others don’t know what to do.”
The tax break on forgiven mortgage debt has been particularly important in South Florida, where home prices dropped 51 percent from the market peak in 2006 to its low point in 2011, according to the Standard & Poor’s/Case-Shiller home price index.
Prices have turned around quickly, but about 28 percent of Palm Beach County homeowners with a mortgage still owed more on their home than what it was worth during the third quarter of last year, according to CoreLogic. Nationwide, 13 percent of homes with a mortgage were under water.
West Palm Beach-based Realtor Rodney Forbes said the largest debt he’s seen forgiven by a lender is $300,000, which would have resulted in $84,000 in taxes for a single filer in the 28 percent tax bracket. Forbes is confident an extension is imminent.
“How can you get money from a person who doesn’t have any money,” he said. “There has to be some common sense somewhere.”
