Short sale? Foreclosure? You're on the 'fiscal cliff'

A provision that eliminates federal taxes on forgiven debt expires Dec. 31. State attorneys general are lobbying to extend the tax break.

By Teresa at MSN Real Estate Dec 12, 2012 7:32AM

© JupiterimagesThe attorneys general of 41 states have joined housing industry advocates, members of Congress and U.S. Treasury officials seeking tax relief for a group that is going to fall hard off the "fiscal cliff" at the end of the year if Congress doesn’t act.


That would be those who have lost homes to foreclosure, done short sales or deeds in lieu of foreclosure or received mortgage modifications that included principal reductions.


Under U.S. tax law, forgiven debt is considered income and therefore is subject to federal income tax at regular rates. Normally, if you sell your home in a short sale or lose it to foreclosure, you could end up owing the IRS thousands of dollars. The same goes for those who received a principal reduction.


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Under the Mortgage Forgiveness Debt Relief Act of 2007, the federal government said that mortgage cancellation on a primary residence was not a taxable event, as long as the money was used to buy, build or improve the home. (If you took out a second mortgage to send your kids to college and the debt was later forgiven, you still may be on the hook for taxes.) The act applies to up to $2 million of forgiven debt.

But that provision expires Dec. 31. So far, although policy wonks say the provision will be extended, it has not been.


That means if you sold your home for $200,000 less than you owed, and the bank forgave the debt -- not an unusual scenario in areas where homes are expensive and values fell substantially -- you could owe $50,000 in federal taxes if you’re in the 25% tax bracket.

"If the act expires, you will be asking people to pay cash on an income they never received and with cash they don’t have," John DiBiase, communications director for the National Association of Realtors’ government affairs office, told The Palm Beach Post.


The attorneys general argued in their letter to Congress that requiring homeowners to pay taxes on forgiven mortgage debt would negate the benefits of the $25 billion settlement reached with the big banks, which encourages short sales and principal forgiveness.

"People are already suffering enough who go through default and foreclosure, and to suddenly give them a tax bill is incredibly cold-hearted," Anthony Sanders, a George Mason University real-estate finance professor, told The Palm Beach Post. "The government was a major contributor to the housing bubble and burst, so it’s only fair that it extend the act to help households that have been absolutely crushed by the market."


If the provision is not extended, those who lost their home to foreclosure may be able to avoid a big tax bill by showing they were indigent, using IRS standards, at the time the home was sold. But not everyone in that situation will meet the test. Bankruptcy is another option, but it brings its own set of problems.


What do you think? Should the act be extended? Do you think it will be?


Dec 12, 2012 12:03PM

this is to Grandmal.......I agree to a point of helping the families that truly need it but how do you know who those are as we have had our welfare and social systems basically fandalized because generation after generation of childrens childrens think our government owes them a living.  And then we let the illligals have medical and food and who knows what else because we don't have the hootspah to send them back to their own country, all the while they are selling drugs, forming gangs, setting up theft groups that go from house to house for whatever they can find worth a dollar to steal.  We don't have an america any longer it should be renamed "Payashugo"  So now that the is hitting the fan and the fiscal cliff is looming for us all, how do we have the right to call on the Grace of God when we brought this upon ourselves.......IT NEEDS TO STOP NOW AND I SAY LETS TAKE THE PLUNGE OFF THE CLIFF AND START OVER WITH WHOEVER IS STANDING AT THE BOTTOM.

Dec 12, 2012 11:54AM
How about those that lost their jobs and can no longer pay the mortgage because of it.  Not everyone who lost their homes was because they bought more than they could afford. Did you ever think about that  before you start categorizing everyone as irresponsible home owners.
Dec 12, 2012 11:51AM

Sometimes I wish I wasn't so responsible cuz if I wasn't I would have a butt load of money right now.

I say they should pay their dues.


Dec 12, 2012 11:47AM

"Park Avenue: Money, Power and the American Dream" . Everyone should watch this. You mention politicians, and this will tell you all there is to know about our political system and the feigned compassion of all our leaders (and wanna be leaders), their take on your finances and what they are really all about

Dec 12, 2012 11:45AM
God I love it, the biggest RF of our time.
Dec 12, 2012 11:44AM
So, people who lost their job through no fault of their own or became ill and unable to work are somehow responsible for their own bad fortune and we should not have pity on them?  What is happening to our country?

It is only by the grace of God that we all aren't in the same boat!  Show some mercy and extend the law.   You can't squeeze blood out of a turnip but some people seem to enjoy trying.

Dec 12, 2012 11:42AM
First they walk away from their commitment because they want too, and now they don't even have to pay taxes on the money saved. I think responsibility should be removed from the dictionary because  this group of people has redefined it.
Dec 12, 2012 11:41AM
Heads they win, tails you lose.  
Dec 12, 2012 11:36AM
People who bought more home then they can afford, or were complicate in the fraud used in buying the home, should be held responsible for their actions. No more bailout's or the ship will sink!
Dec 12, 2012 11:33AM
Why is it that people who lived beyond their means do not have to pay any consequences of their actions? Te tax payer is on the hook to forgive their debt, now we are going to have to pony up to pay their taxes on their forgiven debt. and yes, that is income, as they signed a contract to pay the bank back and they had someone else (the tax payer(me)) pay it for them. By the time the democrates are done screwing thing aound there will not be a responsible person left in america because they we all be waiting for the Government to give them what they need. America is dying, it is a sad time.
Dec 12, 2012 11:15AM
The law will undoubtedly be extended. Not doing so would be the biggest perversion of tax cruelness in history. But I don't think it's going to happen until next year and will be made retroactive. Which means short sales will dry up in January. Get ready for a more-restricted inventory and higher prices!
Dec 12, 2012 11:07AM
Last time I checked, no one forced these people to buy homes WAY out of their price range.  It's their own stinkin' fault and I'm sick of bailing people out.
Dec 12, 2012 10:46AM
Tax payers are on the fiscal cliff.  Vote buying(welfare)  will continue until the dollar is worthless.
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