NationstarDid you hear the news? Probably by now, you have. Any owners of homes that participated in short sales during 2014 will now be pleased to know that President Obama signed the Mortgage Debt Forgiveness Act into law (or rather, he signed the extension of the Act that originally was drafted in 2007 and had previously expired at the end of 2013).

Initiated by President Bush, this IRS Act was a tax break that saves struggling homeowners from paying thousands of dollars to the IRS. As it stood through the end of 2013, distressed borrowers in certain situations were not be responsible for paying taxes on any of the forgiven debt associated with a short sale, a foreclosure, or a deed-in-lieu of foreclosure. (Note that the amount of debt forgiven is reported on the 1099-C, and sent to all borrowers. It is the borrower that would be responsible for addressing the debt forgiveness when completing a tax filing.)

Prior to the enactment of the Mortgage Debt Relief Act of 2007, if the short sale lender forgave $50,000 in debt, borrowers were responsible for paying the income tax (on the $50k) at their current tax rate.

However, with the Mortgage Debt Forgiveness Act, any mortgage amount forgiven would not be considered income to the seller and therefore it would not be taxable.

Most recently, in early December, the House of Representatives and the Senate passed the extension of the Act for the duration of 2014. Once President Obama signed it into law, it became official.

2015 May Hold Something Different

California homeowners will not face tax penalties when selling their homes in short sale, despite the fact that the benefits of the Mortgage Debt Relief Act of 2007 ended on January 1, 2015.

Thanks to a letter from Senator Barbara Boxer to the IRS, Californians now have that clarification. In November, Senator Boxer received a response from this IRS clarifying that California families who have lost their homes in a short sale will not be subjected to a tax penalty for debt forgiven after the federal law prohibiting such penalties expires at the end of this year, and the Franchise Tax Board has agreed with those clarifications.

Enacted in July of 2011, California has an anti-deficiency law that protects homeowners from lenders attempting to collect additional assets in the case of a closed short sale transaction. But until Senator Boxer wrote her letter, the IRS had not clarified how this might play out in California. Like many Californians, Senator Boxer noted that with the end of the Mortgage Debt Relief Act of 2007 just around the corner, “…distressed borrowers may face the unfortunate incentive to go to foreclosure rather than seek a short sale in order to avoid a large tax bill.”

The IRS reply included excellent news for California homeowners, clarifying that these families will not face burdensome tax penalties as a result of participating in a short sale—specifically because of the state anti-deficiency statutes. With approximately 55,000 anticipated short sales in 2014 in the state of California, this is good news for those distressed borrowers still on the fence about selling as a short sale.

Short Sale Sellers

Any seller considering a short sale in 2015 should speak with both an attorney or an accountant to make sure that the short sale is right for their unique financial and personal situation. As agents, we often get excited about taking these listings, but they are tough. And, nobody wants to work on a deal for months and months only to learn that the seller wasn’t 100% certain about the decision and has decided to go in a different direction. Hopefully, the information in this article will convey everything sellers need to know in order to prepare for a short sale in 2015.