The Mortgage Forgiveness Debt Relief Act of 2007 was established in an attempt to allow short sellers – presumably in a dire financial situation – to avoid a surprise income tax bill the following year. Essentially, it exempts sellers from paying income tax on the difference in what is owed versus the short sale price of the home. The link above will take you to the IRS page with specifics, and absolutely consult your accountant (and probably your attorney) to see if and how it can affect you.
As an example, consider a homeowner who owes $3 million on their home. It sells for $2.5 million. The homeowner realizes “income” of $500,000 – because they were able to satisfy a $3 million debt with only $2.5 million. This Act exempts these sellers from having to pay income tax on the $500,000.
Luxury home sellers face one of the more notable exceptions to this rule. There is a limit to Uncle Sam’s debt forgiveness, but (of course), this limit is also conditional:
“This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.”
In the markets we serve like Paradise Valley, Scottsdale, Arcadia and the Biltmore, the average number of Days on Market for homes closing this month is approximately 130 days. In addition, short sales typically take longer, and the traditionally slow summer is just around the corner. While the average debt to selling price difference is rarely hitting the $2m limit, time is likely to become an issue for short sellers unless they act quickly.
Of course, the Act may also be renewed – it would only take an act of Congress.