| The recent national surge in home foreclosures | | | | payments on the loan for a year, but due to the |
| coming on the heels of the collapse of the | | | | recent slump in the market, the home is now |
| sub-prime lending industry and decline in home | | | | worth only $250,000. He still owes $300,000 on |
| values likely means additional bad news for those | | | | the mortgage. The lender, therefore, may accept |
| former homeowners who feel like they just lost | | | | a reconveyance of the home - in essence a |
| everything: additional income tax liability. | | | | $250,000 payment - against the $300,000 debt. |
| Income tax liability? From losing your home? Such | | | | The sale is "short" because the value of the home |
| is the nature of the United States Internal | | | | does not cover the amount of the mortgage. The |
| Revenue Code. | | | | lender may forgive the additional $50,000 owed |
| Given the foreclosure epidemic and the huge | | | | by the borrower in order to avoid the foreclosure |
| losses to which lenders of all sizes are now | | | | process, or to avoid litigation expenses in pursuing |
| exposed, many lenders are willing to enter into a | | | | the borrower for the deficiency balance, and |
| variety of work-out programs with their | | | | essentially cut its losses. |
| borrowers to avoid foreclosure. Avoiding | | | | For the borrower, he avoids foreclosure and its |
| foreclosure does not necessarily mean keeping | | | | ramifications to his credit, as well as facing a likely |
| the home, however. | | | | judgment for the amount still owed on the debt. |
| The foreclosure process is time-consuming for | | | | The hidden drawback here, though, is that the tax |
| the lenders and often subjects them to the | | | | code treats Joe's debt relief as income. By being |
| additional time and expense of physically evicting | | | | relieved of the obligation to pay $50,000, the IRS |
| the former home owner from the home after | | | | considers that Joe has in effect put $50,000 in his |
| the foreclosure sale. From the borrower's | | | | pocket. |
| perspective, a foreclosure is a huge blow to credit | | | | The debt relief is subject to ordinary income tax. |
| worthiness and will impact the borrower's ability to | | | | Joe may not even know of his additional tax |
| finance major purchases for years to come. | | | | liability until he receives an envelope in the mail |
| Considering many lenders' goals of reducing their | | | | from the lender containing a 1099 form reporting |
| losses on foreclosures, borrowers have met with | | | | the debt relief income to the IRS. |
| success recently in negotiating "short sales" with | | | | The same result may follow if Joe simply walks |
| their lenders. A short sale is the borrower's | | | | away from the home, allows foreclosure to |
| reconveyance of the home to the lender for less | | | | proceed, and then the lender elects not to pursue |
| than the amount owed on the mortgage. | | | | Joe for collection of the deficiency balance on the |
| For example: Joe obtained a creative home loan | | | | loan. |
| and purchased a home at the height of home | | | | The ripple effect of the sub-prime lending market |
| values and during the most liberal period in | | | | over the past couple of years has yet to reach |
| sub-prime lending. | | | | its full effect. Individual homeowners must be |
| Eventually, the appraised value of Joe's home | | | | wary of all consequences of divesting themselves |
| began to drop and the "creative" part of his home | | | | of the homes they purchased in that market. |
| loan kicked-in. Perhaps his interest rate adjusted | | | | While financial planning might be the last thing on a |
| or his interest-only payments ceased and he was | | | | borrower's mind when he or she faces the harsh |
| required to commence paying both principal and | | | | reality that the home will be lost in some way, |
| interest. | | | | the unforeseen consequences of a foreclosure or |
| In any event, Joe finds that he cannot afford to | | | | short sale can only be addressed through the |
| continue making the mortgage payments and, due | | | | sound advice of a tax professional, CPA, or, at |
| to market circumstances, he now owes more on | | | | the very least, the IRS website. |
| the mortgage than the home is worth. In other | | | | Of interest to us lawyers, however, is the |
| words, he is upside down in the home. | | | | approach the IRS will take to the likely spate of |
| Joe defaults on the mortgage payments and is | | | | litigation that will proceed, alleging that these |
| now subject to the foreclosure process. | | | | borrowers, now facing additional income tax |
| Applied to the example above, the borrower | | | | liability through the loss of their homes, should not |
| might successfully negotiate a short sale with his | | | | be responsible for the 1099 income tax burden, |
| lender. Many lenders are now accepting a | | | | by virtue of alleged fraud or misrepresentation on |
| reconveyance of the home and forgiving the | | | | the part of the sub-prime lenders. |
| remaining debt exceeding the value of the home. | | | | As they say, "the Wheels of Justice grind slowly." |
| In the example, Joe may have purchased the | | | | We will all have to wait to see how this shakes |
| home for $300,000. He has made interest-only | | | | out. |