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Short sales stall as Congress mulls tax-relief extension

Homeowners facing foreclosure and fix-and-flip investors are waiting to see if Congress will extend tax relief in short sales.

Short sales — a way for owners of seriously underwater homes to walk away from their loans — could substantially decline this year, pushing financially struggling homeowners into foreclosure unnecessarily, according to investor groups and businesses involved in short sales. That's because these homeowners potentially would face thousands of dollars in federal taxes on forgiven loan amounts once the short sale is completed, if Congress doesn't extend debt relief this year. 

“Homeowners are unclear about the future, and businesses are unclear about the future, which makes it uncertain,” Tom Zeeb, a director with the National Real Estate Investors Association, said in a phone interview. “It is hard to want to move ahead and help people use this certain technique when you don’t know if it is going to be viable because you don’t have stability in the law.”

Financially stressed owners often use a short sale to avoid foreclosure when they owe substantially more on the loan than their home can fetch on the market. After owners prove that they can’t pay their mortgage and are headed to a foreclosure, lenders typically agree to forgive a substantial portion of the original loan. The home is then sold at the negotiated price, and the homeowners walk away with a better credit than if they’d handed back the keys in a foreclosure.

Often these homes wind up in the hands of investors, who fix them up to rent or sell. Otherwise, the properties may sit empty and begin to fall apart, blighting neighborhoods, say supporters of the tax relief.

Since 2007, Congress has passed debt relief that eliminates the federal tax on the forgiven loan amount. Last year, it waited until mid-December to extend the bill to cover the entire year of 2014. It is unclear if Congress will extend the tax relief to cover 2015, however.

The number of short sales “went off a cliff” last year when Congress waited until the last month to pass the tax relief, Zeeb said. Short sales represented 4.5 percent of all sales between January and November 2014, which was down from 5.4 percent for the same period in 2013, according to RealtyTrac. 

Richard Eastern, chief executive officer of Washington Property Solutions, said about half his short sale clients would not be classified by the Internal Revenue Service as “insolvent” and automatically get relief. The tax code already exempts insolvent people from paying tax on the forgiven loan amounts.

Eastern said all his short sale clients are struggling financially even if they are not technically insolvent.  

“It is absolutely a kick-[you]-while-you-are-down tax,” Eastern told Scotsman Guide News. “It is an atrocity to send a tax bill to these people who, frankly, don’t have the money to pay it.”

The Senate Finance Committee is only now beginning to review proposals to extend the relief through 2016. 

John Grant, a Washington, D.C. housing lobbyist, said investors and the short sale industry want Congress permanently to exempt the tax or at least begin to extend the relief over two-year periods. He said that when Congress waits and extends the bill retroactively, it leaves investors and homeowners uncertain. 

“Timing is important with this bill because the work can’t continue until the bill actually passes,” Grant said in a phone interview. “Retroactively doesn’t do any good.” 


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