For those folks experiencing, or about to experience, a “1099 event” resulting from a short sale, deed-in-lieu-of-foreclosure or foreclosure in 2014, these are harrowing times. Will Congress extend the Mortgage Forgiveness Debt Relief Act and Debt Cancellation law (the “Forgiveness Law”)? It was enacted in 2007 so that homeowners would not be taxed on the cancellation of debt that occurs when they dispose of a home that is “underwater,” i.e. the home’s mortgage exceeds its value.
Internal Revenue Code Section 108, says that, subject to certain exceptions, when a creditor cancels a debt, the amount cancelled or forgiven is treated as “income” to the debtor. The creditor sends the debtor and the IRS a 1099-C, identifying the amount of debt cancelled. When the debtor files his or her taxes the following year, they must either pay income taxes on that amount, or file a Form 982, to reduce or eliminate the tax, due to a recognized exception, such as that provided by the Forgiveness Law. To qualify for forgiveness, the following rules apply:
- The home must have been a primary residence;
- It must have been occupied for two of the last five years; and
- The funds forgiven must have been used to buy, build, or substantially improve the home.
Needless to say, if one cannot afford the mortgage payments on their home, and the only way they can sell it – if at all – is through a short sale, it’s crazy to then tax the homeowner on the amount of the funds forgiven. If they can’t afford the home, how will they afford the tax?
The logic of the law is unassailable. That’s why it’s been extended twice, as the country slowly emerges from the Great Recession and the resulting tsunami of foreclosures. Unfortunately, it expired on December 31, 2013. Why? Because the idiots in Washington were too involved in political infighting to focus on their constituents.
As it currently stands, a short sale, deed-in-lieu, or foreclosure that is completed in 2014 will result in a “1099 event” and the taxpayer will be unable to gain the benefit of the Forgiveness Law. In other words, they will have to pay taxes on the cancelled debt. And to underscore the complete idiocy of a failure to extend the law, the federal programs such as HAMP and HAFA, which are designed to encourage bank principal reduction and short sales, would be emasculated, since the homeowners intended to be benefited by the programs would have to pay taxes on the benefits conferred [i.e. debt cancellation].
However, there still is time. Apparently, an extension of the Forgiveness Law, at least through 2014, is part of a much larger series of “extender laws,” i.e. those that the politicians in Washington know their constituents want, but don’t have the backbone to actually pass them into a permanent law – so they just get extended and extended – which apparently is less politically risky. The reason is that many of the extender laws are regarded as political pork, or payoff, to small segments of the constituency [such as Nascar and the rum industry]. While that isn’t the case with the Forgiveness Law, which is politically popular, it has become caught up in the politics of the moment.
Originally, it was believed that the extender laws would, in 2013, become a part of an overhaul of the tax law, but the reds and the blues were so far apart on the issues that it became apparent tax reform would not occur. So now, the pols have to focus only on passing the package of extender laws, which should [hopefully], occur in the next few weeks.
Conclusion. By all accounts, these extenders will be passed, and they will become retroactive to the first of the year. Not necessarily because the politicians really want to help the Little Guy, but because they want to deliver the pork to their more powerful constituents, and the Forgiveness Law just happens to be in the mix. To be sure, no politician would ever pull the Forgiveness Law out of that mix, so the Little Guy gets to benefit – just the same as the Big Boys who own Nascar racetracks and drink Bacardi.