January 2, 2012

The Mortgage Forgiveness Debt Relief Act (the MFD Act) has been extended for one year, until midnight on December 31, 2013, as part of the American Taxpayer Relief Act of 2012 (the act intended to stop us short of going over the so-called fiscal cliff). This is great news for distressed homeowners, preserving their option to go through a short sale without having to pay tax on phantom income (known as 1099 Discharge of Indebtedness Income), when they short sale their primary residence and obtain a waiver of any deficiency claim from the lender (the difference between the amount paid to the lender and the amount owed on the loan). The MFD Act also applies to any other disposition of the primary residence which involves the homeowner not having to be liable for the deficiency claim, such as a foreclosure.

An example tells it all: without the MFD Act, if the lender wrote off $100,000 of the secured debt to permit the short sale to occur, the homeowner would be taxed as if the homeowner had just made an additional $100,000 of income. With the MFD Act in place, the qualifying homeowner would be able to exclude from taxable income the entirety of that $100,000.

The MFD Act was set to expire at midnight on December 31, 2012 (meaning that it would only apply to any closings which occurred before January 1, 2013). Now the MFD Act will cover any closings which occur before January 1, 2014.

Detailed discussion of the MFD Act is beyond the scope of this Alert. While other exclusions from the 1099 income could apply, such as the insolvency exclusion, for the majority of homeowners dealing with underwater loans on their primary residence, the MFD Act was the preferred solution to avoid taxation of that 1099 income, and a failure of Congress to have extended the MFD Act would have been a financial blow to many such homeowners.

DISCLAIMER: This column does not constitute the giving of legal advice, and your reading this column does not create an attorney/client relationship. You are encouraged to consult a lawyer or accountant should you have questions about how this information may be applicable to your particular situation.