There is another financial threat approaching mortgage borrowers. Currently, any mortgage debt forgiven by a lender in a short sale, loan modification or foreclosure is exempt from federal tax. However, beginning January 1st, that exemption will expire.
After the expiration date, borrowers will have to include mortgage relief as income rather than a write-off, which means that a borrower would have to pay taxes on a $100,000 principal reduction or even on a $20,000 write-off after a short sale. There is a strong possibility of an extension of the tax exemption; however there is no guarantee of it based on current negotiations.
Some short-sale lawyers are doing all that they can to make sure their clients do not get stuck with a huge tax bill. The Debt Relief Act exemption can only be applied to canceled mortgage debt that is used to buy, build, or improve a primary resident, but not a second home with the maximum being $2 million.
It seems that borrowers in New York and New Jersey would be hit hardest if the tax exemption is not extended, because both states have a considerably large backlog of foreclosures. New York has a time line of 1072 days, which is three times the national average of 382 days.
While this exemption is reaching its expiration date, borrowers should not rush into the short sale process. Instead they should look at whether a short sale would be the best choice in their situation and consider all other their options.