Many of the properties listed on the market today are short sales, which account for almost a quarter of the listings in the U.S real estate market. The process of completing a short sale, which once took 6 to 9 months or in some cases even a few years can now take as little as 30 days to be approved. For this reason many homes being purchased by investors in 2012 are short sales. Short sales listed for sale on the market have been growing rapidly and have increased by 22% since last year.
A short sale occurs when a lender agrees to accept less than the full amount that is owed against a property. This typically occurs when homeowners are underwater and owe substantially more on their home than their home is currently worth. Many of these homeowners may consider walking away from their homes but would rather sell their homes to an investor than have a foreclosure on their credit report for ten years.
One important factor in short sales is the Mortgage Forgiveness Debt Relief Act which was introduced in Congress on September 25, 2007, and became law on December 20, 2007. The Mortgage Forgiveness Debt Relief Act of 2007 offers relief to homeowners who would formerly owe taxes on forgiven mortgage debt. What this means is that cancelled mortgage debt would not be treated as taxable income and no taxes would be due on forgiven mortgage debt like in the case of a short sale.
When a homeowner sells their home to an investor via the short sale process, the bank agrees to accept less than the full amount owed on the mortgage. The difference between the amount owed on the mortgage and the sales price is currently not taxed (as long as it is a primary residence). Normally forgiven debt is considered taxable income and a 1099 is issued but the Mortgage Forgiveness Debt Relief Act of 2007 allowed home owners that were underwater to sell their home via the short sale process without having the burden of having to pay additional taxes on the forgiven debt.
If existing laws are not changed before the end of 2012 one of the resulting effects of the “Fiscal Cliff” will be that the Mortgage Forgiveness Debt Relief Act of 2007 will expire at the end of the year. While both sides of the political aisle are engaged in a 1950’s game of chicken, they fail to recognize that real people will be hurt as a result of their bickering.
Middle class families who are climbing their way out of debt will not be able to get a fresh start when they have hundreds of thousands of dollars in negative equity and are not able to complete a short sale because of the tax consequences. Investors will see inventory dry up as less short sale listings on the market will result in less inventory and prices will rise. This is not good for the first time home buyer looking to achieve the American dream of owning their first home at an affordable price.
The alternative for families looking to sell their home via the short sale process will be for them to choose to stay in their home without paying and allow their home to go into foreclosure. This is not good for the banks or the economy and produces a huge back log in our court system which is already overburdened with foreclosure cases. This is not a very efficient way to deal with the housing crisis.
In other words, what we have here is a perfect government solution to the problem. Washington D.C. politicians simply do not understand how vital short sales are to the economic recovery. Short sales account for more than 40% of the sales volume in Rhode Island, Massachusetts, and Connecticut. In my home state of Florida, short sales account for 29% of all sales.
The banks have a huge problem. They have too much inventory of homes that are negative equity. The real estate market must recover in order for the economy to recover. While prices are beginning to increase it is important to understand that making it more difficult for home owners that are underwater to initiate a short sale by taxing them is not good for the economy or the recovery. Washington D.C politicians need to consider this as we approach the “Fiscal Cliff”.
Middle income families who are underwater on their homes will suffer the most. Nationally, short sales are completed on average for a sales price of $94,896 less than the mortgage balance owed. This means that middle class Americans who wish to sell their homes next year via the short sale process will have to pay income taxes on almost $100,000 more income.
This is absolutely ridiculous, especially if they start taxing incomes over $200k at higher rates. Working families could see their income taxes double as a result of the tax increase, due to moving into a higher tax bracket and having to pay income taxes on the forgiven mortgage debt.
In states like California and Nevada, the average short sale is completed for $171,907 less than the mortgage balance owed. Imagine a scenario where a middle class wage earner making $50k a year is considered rich because their taxable income exceeds $200,000 because they completed a short sale.
The middle class is getting steam rolled by both parties. Big banks like Bank of America, JP Morgan, Wells Fargo, and Citi Group all got their bailouts. It is absolutely absurd that politicians are playing this game with this Washington D.C manufactured Fiscal Cliff while underwater middle class families struggle to recover from the housing crisis.
I hope that the politicians come to their senses and extend the Mortgage Forgiveness Debt Relief Act of 2007 and do not let it expire at the end of the year.