On Dec. 31 of last year, the Mortgage Forgiveness Debt Relief Act, which made it possible for many homeowners to avoid paying taxes on debt forgiveness due to foreclosure or short sale, expired. Many are hopeful that Congress will renew the Act, which became law in 2007. Even though the law appears to have sufficient support, Congress has yet to make a determination regarding renewal of it. This has — and may — cause numerous homeowners in New Jersey and across the country to file for bankruptcy after a short sale of their homes.
In a short sale, a home is sold for less than the mortgage on the property. The lender must approve the transaction, and any balance on the loan is often forgiven. This sounds like a good deal until homeowners realize that, without the MFDRA in place, they could be on the hook for a large tax bill. This is because the IRS considers any amount forgiven by a lender as income and, therefore, taxable.
Obviously, the more debt forgiven by a lender, the higher the tax bill could be. This is causing many homeowners to second guess whether they should attempt to short sale their homes. A short sale may relieve a family of the burden of its mortgage, but unless Congress renews the MFDRA, that relief may only be temporary until tax time rolls around.
Some homeowners may choose to file for Chapter 7 bankruptcy just in case Congress decides not to renew the Act. This may seem extreme to some New Jersey residents, but when a family already in financial distress is facing a tax bill that could easily climb into the thousands of dollars, it may actually be a practical and responsible solution. Any discharge of debt through a bankruptcy proceeding is not taxable as income. This could give a family the opportunity to start fresh with a clean slate.
Source: Los Angeles Times, “Congressional inaction on debt forgiveness bill affects short sales“, Kenneth R. Harney, June 8, 2014