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Fiscal cliff hits underwater homeowners

By Polyana da Costa · Bankrate.com
Wednesday, November 28, 2012
Posted: 12 pm ET

A crucial tax break for underwater homeowners that expires in less than five weeks may get overlooked as Congress tries to tackle the so-called fiscal cliff, housing advocates fear. Failure to extend the break would result in devastating consequences for homeowners and the housing market, they say.

Homeowners who owe more on their mortgages than their homes are worth have benefited from the the Mortgage Forgiveness Debt Relief Act since 2007.  The law exempts homeowners from having to pay federal taxes on the balance of their mortgages after a foreclosure or short sale.

The exemption expires Dec. 31. If Congress doesn't extend the tax break, many sellers and even borrowers who receive a loan reduction through a modification could be hit with huge tax bills in 2013.

"Sellers who are in the process of short selling are really worried,"says  Patty Da Silva, a short-sale specialist and owner of Green Realty Properties in Davie, Fla. "They ask me: 'Have you heard any updates, have you heard anything?'"

Da Silva says one of her clients is selling her house for about $220,000 less than the balance of the mortgage. Without the tax exemption, her client could be liable for almost $50,000 in federal taxes, she says. That's because the Internal Revenue Service treats the "forgiven" amount as income even though the seller is not actually collecting any money at closing.

Tony Hutchinson, a senior policy representative at the National Association of Realtors, says Congress will likely extend the tax break as it works to avoid the fiscal cliff, but the uncertainty has already started to affect the housing market, he says.

"Our members are very worried about this because their clients are asking them whether they should place a short sale on the market or hold off until next year when there is more certainty," he says. "Keeping any properties off the market will retard our fledgling yet growing recovery."

If the law is not extended by the Dec. 31 deadline, Congress could still extend it in early 2013 and make the law retroactive. But that would still disrupt the market temporarily, he says.

"The issue is not the mechanics of the forgiveness but the perception," he says. "The key reason many want it extended is because if folks do not think it will be, they'll not short sell."

Last week, attorneys general in 43 states joined efforts and wrote a letter to Congress urging the extension of the legislation that provides the debt cancellation tax break.

"Each of our offices receives calls everyday from homeowners trying to save their homes or struggling to recover from losing their homes," the letter read. "Requiring a homeowner to pay income tax on forgiven or canceled mortgage debt would make the National Mortgage Settlement much less effective."

Will you be affected if the fiscal cliff affects the Mortgage Forgiveness Debt Relief Act? Tell me about it @PolyanaD.

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5 Comments
Sara
November 30, 2012 at 10:38 pm

People need to qualify for a short sale with a hardship (loss of job, death of spouse, or major medical issue e.g cancer and can not work). Once they qualify under these strict conditions how can they afford the large tax (I'm in California and the difference is in the 100's of thousands of dollars). It is odd to think they lost their home and familiar surrounding because they could no longer afford the house. If this is not extended what will happen to these families?

Joseph
November 30, 2012 at 1:45 pm

I am thinking of withdrawing my IRA early to pay off my mortgage. How much will I have to pay if I take it out. About 77,000. That doesn't pay for my full mortgage but I will put up the rest in cash. Also, should I take it out this year or next year after the Obama tax hike? I appreciate any help.

Thank you

Annabel
November 29, 2012 at 5:28 pm

PLEASE, Congress renew this tax break! I am retired and my mortgage is paid, but I faithfully support those who will be so adversely affected should lawmakers FAIL IN THEIR DUTY to renew this tax break.