On the hook for short-sale debt

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Dear Debt Adviser,
Two years ago, I sold my home via short sale and was told by the mortgage company that about $6,000 of the money that I still owed was forgiven. I declared this amount on my taxes, not knowing about a tax law passed in 2007 that forgives this kind of thing. Worse, I just received a call from the recovery department of the very same mortgage firm, saying I’m now expected to pay the “forgiven” amount — but that they’re willing to settle the debt for half that. Can the mortgage company come back to a seller two years later and demand that money? Or is this some kind of scam?
— Cecele

Dear Cecele,
You have two issues here, one of which is a “back issue.”

First off, make sure the person who contacted you was really a representative of the lender. There are several reports of scams out there. Call the lender back to confirm the caller was acting on its behalf.

If it is your lender, we should address the mortgage firm’s move to recover the old short-sale debt, or deficiency.

Some state laws have made it tougher, if not downright impossible, for lenders to collect such short-sale debt. But others allow lenders to have free rein unless, that is, you had the foresight to get your mortgage company to agree to a “waiver of deficiency.”

While I certainly don’t doubt that someone in your lender’s office made a verbal promise saying you’d be totally off the hook when the deal was done, it could be pretty tough to prove in court. So barring something in writing, stating that you aren’t responsible for the deficiency … well, you know the rest.

The amount at stake, $3,000, probably wouldn’t be worth taking the mortgage company to court over. But you should feel free to discuss the issue with a real estate attorney who may recognize other recourses based on more information than you’re supplying me here.

Now to the matter of your 2007 tax treatment. The law change you missed is called The Mortgage Forgiveness Debt Relief Act of 2007, which was signed into law in December 2007. It was designed to relieve taxes on forgiven debt, previously considered by the IRS as “phantom income” that is realized in a short sale or foreclosure. It applies to most relief given after Jan. 1, 2007, and through 2012.

The good news is you can correct your little faux pas by filing an amended return for the 2007 tax year, using Form 1040X,  the Amended U.S. Individual Income Tax Return. Be sure to explain the change very clearly on the amended return. Such amendments are common and shouldn’t be a red flag for an audit, should that concern you.

You should also try to negotiate the $3,000 deficiency down another grand or so. When you hear, “We’ll settle,” that usually means there’s room for more negotiation. Make sure you mention to the mortgage company that you believe it gave you wrong or even deceptive information when you made your short-sale decision.

Good luck!

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