Government and the Default Mess
September 5, 2007
Last Friday, President Bush outlined a plan allegedly designed to help potentially hundreds of thousands of sub prime borrowers avoid foreclosure and to modify existing tax code that taxes "relief from debt".
What is "relief from debt"? A homeowner offers his property for sale, but finds that prices have dropped and the homeowner will be unable to sell at a price that would pay off all the loans and the additional costs of sale. The homeowner is able to negotiate with the lender for a "short sale". A "short sale" is one in which the lender agrees to a lesser amount than is owed and will agree to issue a reconveyance deed thereby allowing the homeowner "relief from debt".
The homeowner who participates in a "short sale" will no longer be a homeowner as the property will be sold. "Short sales" are not a means of allowing homeowners to retain ownership and continue to live in the property. They are a method of permitting mortgaged properties to be sold in a declining value market. They are also a method of selling properties that are under notices of default where the amount of the loan is greater than present market value.
The U.S. tax code, however, has a regulation which requires the lender in a short sale situation to issue a 1099 statement to the former homeowner in the amount of the debt that was not collected. That negotiated "short sale" leaves the former homeowner with an income that will be taxed as ordinary income.
For the homeowner who has fallen behind on loan payments, this tax often comes as a shock. It complicates the decision to participate in a "short sale".
It is unclear whether an actual foreclosure would have avoided this taxable income. In both a "short sale" and a foreclosure, the homeowner's credit is affected and the homeowner becomes homeless. In my opinion, modifying the tax code to eliminate this "after loss" burden would have some positive effects for the economy, if not for the homeowner who loses his home.
Tomorrow, I will address some benefits to the economy that this tax code change could create.
Last Friday, President Bush outlined a plan allegedly designed to help potentially hundreds of thousands of sub prime borrowers avoid foreclosure and to modify existing tax code that taxes "relief from debt".
What is "relief from debt"? A homeowner offers his property for sale, but finds that prices have dropped and the homeowner will be unable to sell at a price that would pay off all the loans and the additional costs of sale. The homeowner is able to negotiate with the lender for a "short sale". A "short sale" is one in which the lender agrees to a lesser amount than is owed and will agree to issue a reconveyance deed thereby allowing the homeowner "relief from debt".
The homeowner who participates in a "short sale" will no longer be a homeowner as the property will be sold. "Short sales" are not a means of allowing homeowners to retain ownership and continue to live in the property. They are a method of permitting mortgaged properties to be sold in a declining value market. They are also a method of selling properties that are under notices of default where the amount of the loan is greater than present market value.
The U.S. tax code, however, has a regulation which requires the lender in a short sale situation to issue a 1099 statement to the former homeowner in the amount of the debt that was not collected. That negotiated "short sale" leaves the former homeowner with an income that will be taxed as ordinary income.
For the homeowner who has fallen behind on loan payments, this tax often comes as a shock. It complicates the decision to participate in a "short sale".
It is unclear whether an actual foreclosure would have avoided this taxable income. In both a "short sale" and a foreclosure, the homeowner's credit is affected and the homeowner becomes homeless. In my opinion, modifying the tax code to eliminate this "after loss" burden would have some positive effects for the economy, if not for the homeowner who loses his home.
Tomorrow, I will address some benefits to the economy that this tax code change could create.
posted by shirley harry at 7:48 AM
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