With tax break for short sales set to expire, bankruptcy cases offer a way out

Home values in the Lawrence, Methuen and Haverhill areas have been hit hard. Even Andover and North Andover homeowners have seen big drops in value and lots of negative equity. Many have turned to short sales and deeds-in-lieu of foreclosure to get out of their “problem house” when they need to move. Soon many more might be turning to bankruptcy court instead.

The reason is that a 2007 federal tax break for short sales is due to expire at the end of 2011. Come January, short sales will be fully taxable to homeowners again. Given the potential tax liability involved, bankruptcy will look like the much better option to lots of folks around the Merrimack Valley.

A quick example: Homeowner bought house in Methuen for $400K a few years ago. His mortgage is still $300K. The house is only worth $200K in today’s market, though.

In this example, if the mortgage company agrees to a short sale for $200K, they are forgiving payment of $100K of debt. With no tax break for short sales in 2012, the mortgage company has to send a 1099-C to the IRS showing “income” of $100K, equalling the forgiven debt. When homeowner goes to pay his 2012 taxes watch out — he has to add $100K to his income and pay taxes (state and federal) on it. Ouch!

Filing bankruptcy BEFORE there is a tax problem solves the problem, however. Then the homeowner has no personal liability for the mortgage debt, and can walk away clean. (He will, of course, have the bankruptcy on his credit report for several years, but for most folks, that beats writing five figure checks to the IRS, especially when their bank accounts are tapped out).

There is always the possibility, of course, that Congress will extend the tax break or even re-enact it after it expires. But you just can’t predict that. So, if short sales are no longer practical, look for bankruptcy to be the option of choice for Merrimack Valley homeowners who need to be on the move.

 

By Doug Beaton

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