Will The Mortgage Forgiveness Law Be Extended?

Background. In 2007 Congress passed the Mortgage Forgiveness Debt Relief Act.  The gist of the law is that for those taxpayers who have had debt cancelled as the result of a principal write-down, short sale, deed-in-lieu, or foreclosure, the ordinary income tax that would normally be assessed is forgiven. There are two primary qualifications: (a) The cancelled debt only applies to loans used to buy, build, or substantially improve a primary residence, and (b) The home must have been used as a primary residence for two of the last five years.  Specifics of the law can be found in an IRS Bulletin, here.  The law is set to expire December 31, 2012.

Until now, Congress, suffering from chronic ADD and being unable to multi-task, could not focus on anything but the 2012 election.  Now that the election is over, Congress is dealing with other items, such as the “Fiscal Cliff,” Dodd-Frank, and everything else they ignored for the past 11 months.

The Latest Rumors. Regarding a possible extension of the Act, the American Banker recently reported that…drum roll please…There is nothing new to report. Strong speculation is that toward year’s end, perhaps tied to another bill, an extension will occur.  We all know that while some segments of the economy are slowly improving, there are many folks still struggling to stay afloat with negative equity in a home loan they can no longer afford.  Many of them will ultimately engage, voluntarily or involuntarily, in some form of pre-foreclosure event, such as a short sale or deed-in-lieu.  To tax them as if they had received “income” would seem unduly harsh, and probably something that neither political party would want to be seen supporting.

Is a One Year Extension Long Enough?  But here’s my concern:  As the economy improves, some legislators may want to grant an extension a year at a time.  While 12 months may seem sufficient, it really is not. Right now, in Oregon, we have no idea how long it will be for those homeowners queued up in the soon-to-be-foreclosed line to actually be foreclosed.  And once they get their foreclosure papers – a summons and complaint in most instances – it is hard to know how long it will take for the banks’ lawyers to complete the process. With current backlogs, it could take six months just for the judicial foreclosure to be completed – at least this is what I am currently seeing.

We know that it can take over eight months to get served foreclosure papers – and that is probably an under-estimate when it comes to the Big Banks.  Eight months plus six months is 14 months; i.e. into 2014 if the borrower is only now falling into default.  In other words, if you’re still current on your home loan – but just barely – chances are that a default now will not result in a completed foreclosure in 2013, at least at the present pace. 

Conclusion.  For borrowers whose New Year’s resolution is to close this unpleasant chapter in their lives and move on, a short sale is clearly the best choice.[1]  As discussed here and here, the Portland Metro housing market is slowly improving, both in buyer demand and pricing. The only thing it really needs now is more inventory.  This bodes well for proactive homeowners who are trying to extricate themselves from a mortgage they can no longer afford, or a home in which they will see no equity for another five years – or more.

[1]  Lest you think a deed-in-lieu would be faster, think again.  The banks want the homeowner to sell the home.  Only if they make a good faith effort at doing so, e.g. over a 4-6 month period, will they even discuss the possibility of taking the home back in lieu of foreclosure.  And remember, when the borrower moves from the short sale line to the deed-in-lieu line, they have to start all over again with a new hardship letter, updated financials, etc. They’re at the back of another line! Given the backlog of work the foreclosure attorneys are experiencing, it would not be unreasonable to also believe that trying to complete a deed-in-lieu before the end of 2013 would be difficult.