Soon the U.S. Senate Finance Committee will consider legislation that would aid underwater homeowners by expanding their ability to sell their homes at market price.
The bill would extend the Mortgage Forgiveness Debt Relief Act through 2016, curtailing tax penalties for low- and middle-income homeowners and their creditors who wish to use short sales to cut mutual losses.
Short sales occur when lenders permit struggling borrowers to sell their homes for less than the balance of their mortgages. They are freed from holding onto a property on which they cannot make payments, and which is priced too high to sell. Lenders may forgive the balance of the mortgage. Both parties avoid the harsher ramifications of foreclosure. Although homeowners do not profit from such sales, since they owe a larger sum to the lender than the property can sell for, under current IRS guidelines the amount which is “short” is reported as income.
Without Senate action, however, short sales will continue to wither, causing homeowners and neighborhoods to do the same. A multi-year extension of the act would solidify a crucial tax break on forgiven debt for short sellers and buyers.
Short sale transactions declined dramatically in 2014 because Congress did not pass this tax break extension until December. Without the break in place, underwater homeowners and potential short sale buyers were reticent to execute the transaction because of the potential negative tax consequences. That reticence will continue until the Senate extends the break long-term.
Removing obstacles to short sales would unleash their potential to serve struggling homeowners, buyers, lenders, local communities and even governments. An oft-cited TowerGroup study found that a foreclosed property costs the lender alone an average of $58,000. The longer a property is in distress, the more likely it is to fall into disrepair and abandonment. Once a foreclosed property is vacated, it often draws criminal activity, hindering both the safety and neighboring property values of the community.
Conversely, houses acquired via short sale attract buyers capable not only of investing in their homes, but of spurring local economies through contract labor and other avenues for disposable income. Meanwhile, governments benefit from real estate, sales, and use-tax revenues as buyers, local businesses, and lenders are permitted to mitigate losses and prosper.
Trusting borrowers, lenders, and buyers to be the best judges of their own self-interests when considering short sales is an economic stimulus sure to benefit all parties. The Senate should pass the legislation and give buyers a tax break to bank on.