The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the 2007-2012 discharge of acquisition debt, such as purchase, building and improvement costs, incurred on their principal residence but not on second homes or investment properties. The act helps homeowners facing foreclosures or who sell in a short sale by excluding up to $2 million of forgiven debt ($1 million if married, filing separately), provided the discharge is due to the decline in the home’s value or the taxpayer’s financial condition.
If the lender agrees to forgive the debt, then the lender will send a 1099-C Cancellation of Debt Form. Lenders are required to send a 1099-C form when they cancel any debt of $600 or more. For more information from the IRS, visit www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation. The owner then will report the forgiven debt on their tax return, specifically on Form 982.
The Mortgage Forgiveness Debt Relief Act is set to expire at the end of 2012. Some have argued that the expiration of this act could reduce sellers’ motivation in seeking a short sale. Without an extension to the act, a seller most likely will be unable to benefit from tax relief in a transaction that does not close in 2012 and is pushed into 2013.
The National Association of REALTORS® argues that if the act is not extended, it will continue to place pressure and uncertainty on sellers already experiencing financial trouble and adding to their financial burden. While NAR has been and will continue to push the importance of this issue, it also reached out to each state’s REALTOR® community in a Call to Action on November 15, 2012. Look for more to follow. For more information from NAR on the importance of extending the act and congressional action needed, visit www.ksefocus.com/billdatabase/clientfiles/172/6/1681.pdf.
If there is no congressional action to extend the act, the practice pointers on the next page will assist brokers working with short sale sellers. Wis. Admin. Code REEB 24.03(c) provides that “Licensees shall be knowledgeable regarding laws, public policies and current market conditions on real estate matters and assist, guide and advise the buying or selling public based upon these factors”; meaning brokers working in short sale transactions should alert the seller and buyer regarding the act and its possible expiration. Providing the information found at www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation may be prudent.
Although many sellers facing foreclosure and short sales cannot afford an attorney or accountant, this does not change the fact that licensees cannot provide legal or tax advice. Licensees can, however, provide information and suggest alternatives.
- For pending short sale offers, brokers may emphasize to the parties the importance of meeting all closing dates scheduled prior to December 31, 2012.
- If parties wish to extend a short sale closing until after December 31, 2012 or the lender is not providing short sale approval in time to close by December 31, the broker may recommend that the parties consult with their tax advisor about the implications if the closing occurs after December 31.
- For new short sale offers, brokers should be sure that parties understand that if the offers do not have a scheduled closing before December 31, there is a risk that any amounts forgiven will be taxable to the seller.
The impact of the act expiring could become a material adverse fact should a short seller decide to not go through with the sale because of the tax consequences. If the agent, as a competent licensee, knows that a seller’s decision to not sell based on the expiration of the act is information that indicates that the seller is not able to or does not intend to meet his obligations under the contract, this constitutes an adverse fact. If a party to the transaction were to so indicate, or if a competent licensee would generally recognize that these circumstances are of such importance that it would affect a reasonable party’s decision to enter into a contract or would affect the party’s decision about the terms of the contract, the information is both adverse and material. If both adverse and material, then Wis. Admin. Code REEB 24.07(2) requires the licensee to timely disclose the circumstances in writing to all parties to the transaction, even if the client would direct the licensee not to disclose.
If the licensee knows or is aware of information suggesting the possibility of a material adverse fact, Wis. Admin. Code REEB 24.07(3) states that the licensee will be practicing competently if the licensee makes timely written disclosure of the information suggesting the material adverse fact to all parties to the transaction, recommends the parties obtain expert assistance to inspect or investigate for the possible material adverse fact, and, if directed by the parties, draft appropriate inspection or investigation contingencies. The duty to disclose has priority over any duty owed to the client. See the October 2009 Legal Update, “Diligent Disclosure,” at www.wra.org/LU0910 for further discussion of licensee disclosure obligations.