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CHICAGO (MarketWatch)—An increasing number of homeowners who are underwater on their mortgage are selling their homes by short sale, and that could become an even more popular option during the rest of the year.
That’s partly because of a law set to expire at the end of 2012 that offers tax relief for homeowners who sold their home in a short sale or have had some other sort of mortgage debt forgiven or canceled, such as in a foreclosure or modification that included principal reduction. While there are efforts in Washington to extend these tax benefits, it’s hard to guess whether they’ll be renewed.
So those who think they might be able to take advantage have been stepping up, while they still can.
“Everybody [considering a short sale] needs to talk to a CPA and see if now is the time for them to get off the Titanic and in a lifeboat before this law expires,” said Marge Peck, associate broker and co-owner of Discover Arizona Real Estate in Mesa, Ariz. The company specializes in short sales. “I’ve just hired more staff. We’re prepared for the tsunami of people saying ‘I’ve waited long enough, nothing’s going to change.’”
Short sales are transactions in which the borrower owes more than the home is currently worth, and the lender agrees to accept less than the full mortgage payoff at closing.
The current savings for taxpayers is significant.
Say a homeowner took out a $200,000 mortgage on a home, and subsequently became underwater by about 20%, or $40,000, during the housing downturn. Without the current tax law, if the bank forgives that amount the borrower is underwater, such as through a short sale, they’d be subject to pay taxes on that forgiven amount, since the Internal Revenue Service regards it as income.
So for someone in the 25% tax bracket, forgiveness of $40,000 would mean a $10,000 tax bill at the end of the year, says Mark Luscombe, principal federal tax analyst for CCH, a Wolters Kluwer business and a provider of tax, accounting and audit information, software and services.
“Of course, the concept always strikes people as strange. They’re struggling and trying to get debt forgiven and then are hit with a tax,” Luscombe said.
To help taxpayers during the housing bust, Congress passed the Mortgage Debt Relief Act of 2007, removing that tax burden. For taxpayers, up to $2 million of forgiven debt (or $1 million for those married filing separately) is eligible for the exclusion, according to IRS.gov. Read more at IRS.gov.
The law has been renewed once already, Luscombe said. Trade groups such as the National Association of Realtors are currently lobbying for the relief to be extended once more.
But eventually this law is expected to expire. It’s just a matter of when: “This one is probably going to sunset at some point. It’s a question of whether Congress thinks this is the right time or not,” Luscombe said.
It’s also worth pointing out that taxpayers in so-called “non-recourse” states may be protected from having to pay these taxes even when the law expires, he pointed out. Homeowners would be best served by seeking out the advice of a tax specialist for help in their local area.
Short sales rising
Short sales made up 9.1% of all home sales in March, up from 7.39% in March 2011, 6.67% in March 2010 and 4.79% in March 2009, according to figures from CoreLogic, a provider of consumer, financial and property information.
By Amy Hoak, MarketWatch.com