I recently watched the movie “Margin Call” starring Kevin Spacey and Jeremy Irons among others. The movie takes place over a 24-hour period on Wall Street in 2008 and focuses on the beginning of the financial crisis caused by mortgage back securities. The storyline follows what happens after a junior member of a fictitious brokerage firm in the risk analysis department realizes that the mortgage-backed securities they have been selling for the last two years are now only worth pennies on the dollar and, if called in, the firm would be shut down. The movie then follows the next 24 hours and takes you through the decision making process that took place and how the firm acted in an attempt to limit its losses and survive the crisis.
Over the last eight years as a bankruptcy and foreclosure defense attorney, I have seen the aftermath of Wall Street’s greed on hard-working Americans who simply were pursuing what they believed to be the American Dream of homeownership. However, the movie depicts callous Wall Street brokers who viewed the circumstances that they created as simply a means of making money as if it were a game. While nothing can be done to rewrite history and rapidly increase the values of property, Congress in the past has approved legislation that would relieve some of the burden of conducting a short sale.
Whenever debt is forgiven, generally it is treated as income. For example if you settle a credit card dispute and the credit card company forgives $2,000 of the debt that you owed to it, you will receive a 1099 for that debt forgiveness which is reported as income. Therefore, you are taxed at your taxable rate for that $2,000. The same is true for mortgages. I have had clients with properties that are over $300,000 upside down in that what they owe (i.e. exceeds the value of the property by $300,000.) In such a case even if that $300,000 is forgiven by the lender and the lender agrees not to pursue the borrower for that deficiency, it is treated as $300,000 of income for which a borrower would have to pay tax on as income.
A few years ago, Congress decided to create an exception to the debt forgiveness as being treated as taxable income for someone who’s selling their primary residence and was residing in the residence at the time of the sale. In that case, that debt that was forgiven was not taxable. However, the law creating this exception expired in 2013. Congress waited until the end of December 2014 to extend it through the 2014 calendar year for any short sales that closed in the year 2014. However, again, it had not extended the law for 2015. Fortunately, Congress not only recently extended it for 2015 but also for 2016 as well. Therefore, if you are upside down on a house that is your primary residence and are attempting a short sale, if you close before December 31, 2016, you can avoid any taxable consequences for any debt forgiven by your lender.
However, keep in mind that this is only applicable to your primary residence. If it is commercial property or vacant land, you are not able to claim this exception and should consult your accountant for other possible ways to avoid the full taxable impact, such as, if you are partially insolvent.
The other way to avoid any taxable consequences for debt forgiveness, whether it is through the forgiveness of a credit card debt or a mortgage loan, is by filing for bankruptcy. Pursuant to the Bankruptcy Code, any debt forgiven by way of a bankruptcy Discharge is non-taxable. This is another benefit of the Bankruptcy Code. However, it is very important to realize that once a tax accrues, you may not be able to discharge that tax in a bankruptcy filing. What this means is that if you short sale a property that s not your primary residence where there is debt forgiven, the taxable event has occurred and it may not be dischargeable in bankruptcy. Therefore, the timing of a short sale of a nonresidential property is crucial if you are also considering bankruptcy.
Another benefit for some homeowners which was extended by Congress relates to mortgage insurance premiums. Specifically, Congress extended the deduction for premiums paid for qualified mortgage insurance through 2016.
On the education front, if you are a teacher, the $250 above the line deduction that was provided in 2014 has been extended permanently and you may claim it for 2015. Then, starting in 2016, the deduction will be adjusted for inflation. Also, if you are paying college tuition, the above the line deduction of up to $4,000 was extended for 2015 and through 2016. As the cost of college continues to rise, while this is a very small percentage, it is a help.
Finally, in the area of estate planning, there is a great benefit for charities and those wishing to donate funds from their IRA to a qualified charity. More specifically, if you are age 70½ or older, you can donate up to $100,000 a year to a qualified charity from your IRA and those funds are not included as part of your gross income. This provision has been made permanent. Before making such a contribution, you should consult with your investment advisor and accountant.
I am not sure if the reason that Congress extended some of these benefits is because it is an election year but, nevertheless, they will provide a substantial benefit to those facing a short sale, education expenses as well as those wishing to donate to charities from their IRA retirement funds. However, as with any serious financial transaction, I urge you to consult with the appropriate professionals such as your accountant and financial advisors before taking any actions to make sure you are in compliance with all the requirements necessary to qualify for these tax benefits.