Short Sales on the Decline

Posted on May 13, 2014

The expiration of a federal tax exemption for forgiven mortgage debt appears to be scaring borrowers away from pursuing short sales.

New data from CoreLogic, a real estate information service, shows a sharp slowdown in short sales for the first two months of the year.

After peaking at 9 percent of total sales in October 2012, short sales had declined to 5.2 percent by last December, said Sam Khater, CoreLogic’s deputy chief economist. In January, however, they made up only 4.6 percent of sales, a faster pace of decline. And preliminary data for February shows an even steeper drop to 2.2 percent.

While rising home prices are helping to reduce short sales, the quickening pace of decline is likely linked to the Dec. 31, 2013 expiration of the Mortgage Forgiveness Debt Relief Act, Mr. Khater said.

Originally adopted in 2007, the act exempts from taxation any mortgage debt forgiven by a lender in a short sale or loan modification. Unless Congress renews the act, as it has twice before, borrowers will now have to count mortgage relief as income on their federal tax returns.

Say, for example, that a lender approves a property sale for $40,000 less than the homeowner’s outstanding mortgage amount, a situation known as being “underwater.” The homeowner who was released from that debt — in what is known as a short sale — must now report $40,000 in additional income.

The act’s renewal is still a strong possibility, but ongoing uncertainty is causing borrowers to think twice about going ahead with a transaction that might stick them with a debilitating tax bill in the future.

“I probably get a half-dozen calls a week from real estate brokers who say, ‘Can you tell me what’s going on? I have a client considering a short sale,’ ” said Jamie Gregory, the deputy chief lobbyist for the National Association of Realtors. “I tell them I’m fairly certain it’s going to happen, but I can’t tell them when.”

The Senate Finance Committee has approved a package of tax-code extensions that includes renewal of mortgage debt relief retroactive to January 2014 and through Dec. 31, 2015. That package may be brought for a vote before the full Senate after the Easter recess, Mr. Gregory said, but it could stall after that because the chairman of the House Ways and Means Committee wants to take a more thorough look at the extensions.

The Realtors association has long favored making the mortgage debt exemption permanent.

“It’s a matter of fairness,” Mr. Gregory said. “If the lender is foregoing part of your debt, it’s not that you’re making a gain on it. If it’s a short sale, you’re trying to sell and move on.”

Slow action on the legislation is only raising the anxiety level for distressed borrowers, said Elyse D. Cherry, the chief executive of Boston Community Capital, a nonprofit community development organization. Boston Community purchases troubled homes from lenders or owners in a short sale, then it sells them back to the owners at an affordable price.

“Now,” Ms. Cherry said, “our folks are stuck between a rock and a hard place.”

On the one hand, going ahead with a short sale puts homeowners at risk for a higher tax liability. But on the other, she said, “if they don’t repurchase they’re going to be out on the street.”

So far, a couple dozen distressed borrowers have opted to take the bet that Congress “will do the right thing,” she added.

Noting that tax liabilities are not dischargeable under bankruptcy, Ms. Cherry warned that, “in the end, if it’s not fixed, it will be a really serious problem.”

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