As part of continuing efforts to provide relief to homeowners mired in the foreclosure crisis, the Department of Justice recently reached a $16.7 billion settlement with Bank of America. These funds will be applied to the mortgages of eligible borrowers in the form of principal reduction and debt forgiveness in a renewed attempt to avoid foreclosures. As an added benefit to homeowners, $490 million of that settlement will be set aside to help cover potential taxes that arise from forgiven mortgage debt.
The tax consequences for forgiven debt apply mostly to short sales. Short sales provide homeowners with the opportunity to sell their property for less than they currently owe on their mortgage. In these situations, the bank accepts the lower sale price instead of pursuing a foreclosure action, and forgives the remaining mortgage debt. The forgiven amount is considered taxable income by the IRS, and can leave sellers with an increased tax bill. Therefore, the tax forgiveness portion of the Bank of America settlement is welcome news for many struggling homeowners pursuing a short sale.
In 2007, Congress instituted a tax break that spared homeowners from having to pay taxes on the portions of their loans that was forgiven by mortgage lenders. Those “forgiven amounts” arose from borrower-lender agreements such as principal reductions, or deficiency waivers in the case of short sales or even completed foreclosures. Without Congressional action, those amounts would be considered income and result in sizeable tax bills. While the tax credit was renewed twice by Congress since 2007, it expired on December 31, 2013.
The effects of the tax forgiveness absence have already been felt across the country, and particularly in the Florida short sale market. With the tax credit in place, this option was tremendously beneficial to borrowers looking for a fresh start away from an underwater property. However, since the tax credit expired, borrowers have had to face the difficult decision of whether to short sell their property and incur significant tax bill, which in turn has led to a decline in short sales. However, the recent Bank of America settlement has breathed new life into the tax forgiveness program and also short sales.
Until the tax credit is reinstated, tax consequences remain a primary consideration for borrowers attempting to short sell their homes. However, the recent Bank of America allocation of funds does provide some relief from potential taxes, and serves as a glimmer of hope for those who wish to pursue a short sale.
When considering a short sale, it is crucial to consult knowledgeable counsel in order to gain a complete understanding of available options. At DeWitt Law Firm, our experienced short sale attorneys can guide you through each step of the process. Call us today to discuss your case.