Mortgage foreclosure laws may change next year, so if you fear you may lose your house, make sure you get your foreclosure timetable under control. The rules could change in 2014, requiring you to pay taxes on your foreclosure deficit. To find out what anyone behind on mortgage payments and in need of foreclosure help should know, we consulted expert Michael Gregory, creator of the website, Stop Foreclosure Pro.
One of the less heralded parts of the tax bill that was passed and signed in the first few days of 2013 is an extension of the Mortgage Debt Relief Act, which is now set to run through the remainder of this year. Before this law was in effect, you had to pay tax on the money you owed and couldn't pay. "So many people were getting crushed," Gregory says. "They couldn't afford the mortgage, and now they had to pay tax on the money they couldn't pay."
Gregory says the MDRA may not be extended indefinitely. Foreclosure takes a while, so if you're looking to get out from under a house, think sooner rather than later. To benefit from this act (and skip the taxman), the transaction should close by the end of the year.
If you are facing foreclosure, Gregory advises, you must understand these three concepts.
Deficiency: In most circumstances, foreclosure creates a situation whereby the lender receives less than the money owed. This also happens with certain foreclosure avoidance techniques such as short sale or mortgage modification. Whenever a lender receives less than what it was owed, a deficiency is created. Gregory offers the following example: Say you borrowed $200,000 to purchase your home; you paid down the debt to $175,000 and then went delinquent on your loan because you lost your job. You and your lender agreed on a short sale and your home eventually sold for $125,000, which was paid to your lender. That created a $50,000 deficiency (what the lender was paid minus what the lender was owed).
Deficiency Judgment: The legal document that creates the lien against your home, a mortgage or deed of trust, usually allows a lender to sue a homeowner to recover the amount of a deficiency even after the homeowner has moved out of his or her home. This is known as a deficiency judgment. In the above example, your lender might still be able to sue you to recover the $50,000 deficiency even after a short sale has occurred. This can come as a nasty surprise to the homeowner. The good news is that certain states outlaw deficiency judgments (type into your browser "Does [your state name] allow deficiency judgments on home mortgages?"), as do many of the U.S. Government's Making Home Affordable programs (check out the regulations online, then call a counselor). Furthermore, lenders can waive their right to a deficiency judgment (be sure to negotiate such a waiver). Get this agreement in writing, and spend the money to have an attorney review it. "Many a homeowner has been told verbally by his or her servicer or lender that no deficiency judgment will be pursued only to find out otherwise when the homeowner is served with the lawsuit," Gregory says.
Forgiveness of Indebtedness: You are not out of the woods just because your lender has agreed in writing to waive its right to obtain a deficiency judgment. Once that waiver has occurred, forgiveness of indebtedness has been triggered, and the IRS generally considers forgiveness of indebtedness to be income on which you may be taxed. "This is kicking a homeowner when he or she is down," Gregory says, pointing out that in our example, once the lender agrees to walk away from its right to obtain a deficiency judgment for $50,000, the lender must send you a Form 1099-C with a copy to the IRS, disclosing $50,000 of income that must be included in your next tax return.
The Mortgage Debt Relief Act generally eliminates the obligation to pay tax on the shortfall between what you owed on your home and what your lender ultimately received—and that's why extension of the Act is such a big deal for struggling homeowners. The Act only covers homes that are primary residences, and it has a $2 million ceiling. Fortunately, most homeowners are covered.
Make sure your foreclosure timetable is right. The Act has only been extended through 2013. You should plan accordingly and not assume there will be another extension. "Foreclosure resolution usually takes many months, and sometimes more than a year, so develop your strategy and start now," Gregory says.
Stop Foreclosure Pro has more information about foreclosure laws, deficiency judgment tax consequences and foreclosure help.