It is bad enough to loose your home to foreclosure or sell in a short sale, but then the bank comes after you for the deficiency and if you don't pay they 1099 you for the debt forgiveness. What does that mean "they 1099 you for the debt forgiveness." They send notification to the IRS that you were forgiven for tens of thousands of dollars and the IRS taxes you for that. Talk about hitting someone when they are down. The borrower can BK the debt, but with the new law, the only way is through FULL liquidation. You loose it all. However, you cannot BK the tax debt.
Let's say for example purposes, a borrower owed $400,000 in mortgage debt. The market turned and the home was sold in a short sale for $275,000. The borrower would get a deficiency judgement for all the cost of the lender; $125,0000 difference in sales price and payoff, $25,000 in closing costs, $10,000 to $30,000 in holding costs, $20,000 to $50,000 in charges related to the foreclosure process. So, the borrower could be hit will a 1099 for as much as $230,000 in deficiency. Then let's say they are in a 25% tax bracket, they would owe the IRS $57,000 in taxes. This does not go away. No BK, no nothing. The IRS is there for ever.
Friday, the president signed into law the bill, HR 3648, the Mortgage Forgiveness Debt Relief Act of 2007. This law is retroactive to January 1, 2007 and last 3 years. I read it to relieve borrowers of the IRS taxes during this time for debt relief. This is a big step at helping people that the real estate bubble hurt badly. They can see light at the end of the tunnel. I look forward to more information on the bill. They are usually quite long and will have many specifications. One being this is for personal residence only. Check with your Tax advisor if this applies to you.
http://taxprof.typepad.com/taxprof_blog/2007/12/senates-mortgag.html
One more step to helping this crisis. There are 2 more steps I believe they should take:
1. In California, the state with most of the foreclosures, the bank cannot go after the borrower for the deficiency on their principal residence. This should be the rule nation wide. You loose your home and the bank hits you with a HUGE judgement. You are now forced to BK or ride out the judgement. You just lost your largest investment of your life, why be forced to BK and loose everything else. If you loose your home, you probably are not in a position to pay $50K, $100K or even in the example above $230k back to the bank.
2. The second step I believe should be taken is to give borrowers an incentive to sell in a short sale, rather than living in the home for free until foreclosure. One may say, the short sale saves their credit. But no, banks are so strict in that after 3 30 day lates occur on your mortgage your credit is destroyed. I am told there very little difference between one borrower that had 3 30 day lates occur and got caught up versus a borrower that went all the way to foreclosure. They need to change this position. I believe they will in the future, but people need to know now. That way they will take the extra steps to sell short rather than just live for FREE and move on.
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