Good News for Underwater Homeowners

In Bankruptcy by Coolidge Wall

A homeowner is considered to be “underwater” or “upside down” on their house if they owe more to the bank on their mortgage (or mortgages) than the value of the home. Some homeowners in this position are simply unable to sustain the expenses of retaining the home, and unable to continue making payments. There are options other than bankruptcy for those homeowners, but many of those options carry the threat of an increased income tax burden. For example, a homeowner may be able to obtain a mortgage modification that reduces the amount of the debt to match the value of the home or obtain a short sale, where the bank agrees to take a bit less (to a lot less) than what they are owed in order to have the house sold for fair market value – without the delay and expense of foreclosure. Since both of these options include the bank forgiving a portion of the mortgage debt, the default rule in the tax laws requires the bank to issue a 1099 for the amount of debt that is forgiven, which is treated as income to the homeowner. While the tax laws include permanent provisions that are available to some homeowners to exclude this phantom income from income for the year, the rest of the homeowners may be left with a high tax bill. Although the mortgage could have been cleansed in a bankruptcy case, the tax bill resulting from dealing responsibly with the debt load cannot be dealt with in a bankruptcy for quite some time.

The Mortgage Debt Relief Act of 2007 allowed taxpayers to exclude from income the discharge of debt on their principal residence. The application of the Act has been extended several times. The last extension was in December of 2014 and it extended retroactively back to the beginning of 2014, but only applied for 2014. Uncertainty surrounding the further extension of this provision has led many homeowners to question whether they should be proactive in dealing with their mortgage debt, or if they are better off being less responsible and simply walking away from the debt in a bankruptcy. Yesterday, the House passed a tax extender package that is expected to pass the Senate and become law that extends the application of the Mortgage Debt Relief Act of 2007 through 2016 (and for some deals struck in 2016, but finalized in 2017). This extension will give underwater homeowners some certainty in dealing with their mortgages. Obtaining approval from your bank for either a short sale or a mortgage modification is a very frustrating process and requires extensive oversight of the process in order to successfully navigate the process. Many homeowners have found the seemingly impossible process to be possible through the help of an experienced attorney. Any attempt to obtain either a mortgage modification or a short sale will require diligent submission and re-submission of financial data and forms in the process outlined by the bank. The good news for homeowners is that once the Mortgage Debt Relief Act of 2007 is extended through 2016, proactive and responsible homeowners who are able to obtain agreements with their banks on their primary residences will not be penalized with a tax bill.

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