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Why 2012 IS the year of the Short Sale

Posted 02-15-2012 at 04:01 PM by Sunshine Rules

Short sales have been around for several years now, but they take on new significance in 2012 due an upcoming deadline.

First, what exactly is a short sale? A short sale occurs when a property is sold for less than what is needed to pay off any loans on the property. When this debt is cancelled, the lender's obligation by law is to file a 1099-C with the IRS to report the transaction.

Under the Mortgage Debt Relief Act of 2007, if a home was a principal residence in 2 of the last 5 years, generally no income tax is due on mortgage debt that is forgiven between January 1, 2007, and January 1, 2013. (The cancelled debt has to be less than 2 million dollars.)

So why is 2012 different from other years?

Unless Congress extends the deadline, homeowners closing on short sale transactions AFTER December 31, 2012 will owe taxes on the forgiven debt, which the IRS considers to be income.

The tax consequences could be significant. For example, homeowner John does a short sale and the lender forgives $100,000 in mortgage debt. John happens to be in the 25% tax bracket. Therefore John could end up owning the IRS $25,000 in additional taxes for the short sale if the transaction was completed after 12/31/2012. I am not a CPA, and I highly recommend anyone contemplating doing a short sale should discuss the potential tax consequences with their accountant or tax attorney.

Some homeowners may assume that Congress will extend the deadline past the end of this year. However, as evidenced by the First Time Home Buyer Credit that expired in 2010, you can’t always count on Congress to extend programs, even if they are popular.

Don’t be surprised if bank lobbyists start pushing to have this legislation end on it’s intended date either. By allowing the exemptions to end, lenders will be given yet another tool to use against upside down home owners…. “make your payments or we will foreclose in 2013 and you will be responsible for paying income tax on your deficiency…”

Since short sales can take months to complete and sometimes the deals fall through, homeowners considering doing a short sale consider getting the ball rolling sooner rather than later in light of the potential tax consequences of procrastinating.

A word of caution to home owners looking to take the short sale plunge -- lenders must officially forgive the deficiency in writing by December 31st, so make sure the attorney representing you gets a letter from the lender(s) acknowledging that the short fall amount of the mortgage is forgiven.

Many people do not realize that when a lender fails to recover the money owed on the mortgage after a foreclosure or short sale, the lender may pursue the borrower and force them to pay the shortfall via a deficiency judgment. In Florida, lenders can pursue borrowers for deficiency judgments for up to 5 years after a foreclosure sale, and have up to 20 years to collect on the deficiency judgment. Ouch!

That 5 year deadline may change in Florida in the near future, depending on what Congress does with a bill introduced in the U.S. House of Representatives in December (HR 3566) to limit and standardize the timeframe that a mortgage holder can go after a home owner following a foreclosure for a deficiency judgment. The Fairness in Foreclosures Act of 2011 would place a one-year cap on any deficiency judgment, except in states that already have shorter time limits in place.

So what does all of this mean to home buyers in our area? 2012 may be your best opportunity to purchase a home being offered as a short sale, which typically is priced at the lower end of the current market range, before legislation significantly changes the playing field for short sales.
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