John,  I appreciate the information.  This is quite valuable.

I don't know anything CA but are you saying a DIL is better than a SS?

Yes for many homeowners in California a deed in lieu is a much better option than a short sale. 

There are going to be a some very upset homeowners when they get those 1099s for 50 to 100 thousand in the next few months             They are going to be told to go see an attorney.  After some research many Lawyers are going to ask -- why a homeowner with purchase money loans did a short sale? You do not even want to see the other questions which will be asked? 

John, I liked your spin on this one & how you put the whole credit thing aside.  That tends to clog up the issue and people seem to have a hard time seeing clearly (their options that is).

Thanks - After speaking with many homeowners - I have found it best to first discuss their legal exposure and strategic options then discuss tax issues including gains and loan forgiveness and then credit.  They can then assemble the information however they wish.  

Thanks - After speaking with many homeowners - I have found it best to first discuss their legal exposure and strategic options then discuss tax issues including gains and loan forgiveness and then credit.  They can then assemble the information however they wish.  

John, How does the new law 3648 affect the 1099 for deficiency... I have a client that has refied on the 1st mortgage and has a HELOC and needs to do a short sale in Jan. 08?

That is a good question - if you could post a link to the exact text of the law - I would love to review it. 

I have seen conflicting analysis.

John it's HR 3648 The Mortgage Forgiveness Debt Relief Act; Bush signed it right before Christmas (Dec. 21,  '07). The client has a 700k+ 1st that was refied into an Neg-Am Option Arm and also has a 75k HELOC with it.... Now will need to do a short sale since they haven't received an offer in 4 months; would it be better to file bk....I told them to talk with an attorney in Orange County.

Debt Foregiveness Act of 2007

H.R.3648: Mortgage Forgiveness Debt Relief Act of 2007 was signed into law by the President on December 20th 2007.  Please read all the information on this as if effects your "short sale" sellers.

SECTION 1. SHORT TITLE.

This Act may be cited as the `Mortgage Forgiveness Debt Relief Act of 2007'

SEC. 2. DISCHARGES OF INDEBTEDNESS ON PRINCIPAL RESIDENCE EXCLUDED FROM GROSS INCOME.

(a) In General- Paragraph (1) of section 108(a) of the Internal Revenue Code of 1986 is amended by striking `or' at the end of subparagraph (C), by striking the period at the end of subparagraph (D) and inserting `, or', and by inserting after subparagraph (D) the following new subparagraph:

`(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010.'.

(b) Special Rules Relating to Qualified Principal Residence Indebtedness- Section 108 of such Code is amended by adding at the end the following new subsection:

`(h) Special Rules Relating to Qualified Principal Residence Indebtedness-

`(1) BASIS REDUCTION- The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer.

`(2) QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS- For purposes of this section, the term `qualified principal residence indebtedness' means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting `$2,000,000 ($1,000,000' for `$1,000,000 ($500,000' in clause (ii) thereof) with respect to the principal residence of the taxpayer.

`(3) EXCEPTION FOR CERTAIN DISCHARGES NOT RELATED TO TAXPAYER'S FINANCIAL CONDITION- Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.

`(4) ORDERING RULE- If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness.

`(5) PRINCIPAL RESIDENCE- For purposes of this subsection, the term `principal residence' has the same meaning as when used in section 121.'.

(c) Coordination-

(1) Subparagraph (A) of section 108(a)(2) of such Code is amended by striking `and (D)' and inserting `(D), and (E)'.

(2) Paragraph (2) of section 108(a) of such Code is amended by adding at the end the following new subparagraph:

`(C) PRINCIPAL RESIDENCE EXCLUSION TAKES PRECEDENCE OVER INSOLVENCY EXCLUSION UNLESS ELECTED OTHERWISE- Paragraph (1)(B) shall not apply to a discharge to which paragraph (1)(E) applies unless the taxpayer elects to apply paragraph (1)(B) in lieu of paragraph (1)(E).'.

(d) Effective Date- The amendments made by this section shall apply to discharges of indebtedness on or after January 1, 2007.

What is acquisition debt -  One of the Realtors I know, Bob Wilson, did a little tax code research and read to me a link to the tax code.  So this is what his source said the code said.  Based on what he said -    If you have a 500 dollar loan for a 600 dollar property.  You can refi that 500 dollars and still be considered the holder of acquisition debt. 

If you wish to make sure yourself - I would start here... 163(h)(3)(B)

If someone needs a legal opinion backed by mal practice insurance I would have to do some more research and cite checking.  

I suspect the terms "acquisition debt" and "principle residence" are going to result in a lot of legal work over the next few years.    

Regarding the rest of the question... On the Heloc - they could be exposed to a deficiency action and or tax liability.  Bankruptcy may be an option...

I would also consider attempting to work out a deed lieu.

Finally if they are still paying the first or they can bring the first current, there are some legal strategies they may wish to employ.  

John, thanks for the info. House is probably worth $850,000 both loans total $850,000 excluding cost of "short sale" + now about 9,000 in unpaid property taxes. They are current with both loans paying the min. pmt. on the neg-am and the Heloc pmt. too. They have about $100,000 in income but when pay option arm resets (110% reset) payments go to $5,000/mo. range..........Maybe they should wait for reset (around Aug. 08) and then default on the loan. They were trying to sell so the majority of the loan gets paid off and everyone kind of wins. But if they have to pay a deficiency.... bk or foreclosure is a better option. You are saying a deed in lieu would be best. Why is that better than short sale w/ ch. 13 or ch. 7...................they are overextended on everything now just min. pmts. on all. I'm trying to advise but not legally; just as a friend.

Kyle - your friends need to get well-informed legal advice right away and come up with a strategy.  Since they re-fied their 1st mtg, it may now be considered a recourse loan.  There is CA case law that suggests that a non-cash-out refi of a ourchase money loan may still be considered purchase money, but the loan docs need to be reviewed as well on this issue.  Their HELOC sounds like it was taken out post-original purchase, in which case it is a recourse loan and therefore problematic in terms of exposure to a deficiency action.  A short sale may not be ruled out as based upon your description they may have more debt than assets.  If they are insolvent, the tax code gives them a pass on debt cancellation tax, so a short sale can work without adverse tax consequences. 

 They proceed without legal advise at their own risk, and it is significant.

RSS

I agree with RSS.  Your friends need to come up with a work-out strategy while the are capable of making payments.    A good work out strategy could make a large difference to their financial future.  I think they ought to begin with some lenders to their lenders right now. 

There is no way they can do a work-out strategy since they're negative every month now on all living expenses. The "loan work out" will only be more not less than they are paying now. They have talked w/ a Bk attorney and may go the Ch. 7 route with or without a short sale.

John- a follow up to the previous posts. The couple I was talking with decided on  a ch. 13 bk intending on releasing the 1st and 2nd through the process plus a financial regrouping on other debt. Their income doesn't allow for a Ch. 7 bk. They decided it wasn't worth the work especially if the 2nd won't cooperate anyway.

thanks for the update.  

here in Florida the majority of the people I work with do not qualify for a DIL, without the option of DIL, short sale sure beats foreclosure

I am not sure what you mean - do not qualify for a deed in lieu.  I agree that a short sale can be better than a foreclosure if you have a lawyer reviewing he financial statements and the closing paperwork to make sure the liens are released and the obligations on the loans are extinguished.  

But what do you mean - do not qualify for a deed in lieu of foreclosure.  You may be alluding to the fact that a few banks do not wish to accept a DIL on an  upside down property. But in my experience the the largest lenders are happy to consider a DIL.  GMAC, Countrywide, Chase, EMC, and many others all consider them.  Finally don't listen to the Realtor trainers who say you can't do a Deed in Lieu for two loans.  It can be done, easily,  it just takes a lawyer to draft the proper paperwork.  

I sent in my paperwork for a deed in lieu of foreclosure 3 weeks ago to Countrywide. They told me it would take between 30 and 60 days for everything to go through. I have my home for sale and have some nice leads as it is priced way below market value which would obviously be the best way out of my mess, however in this market who knows. My question is for anyone who knows what happens to my HELOC after a deed in lieu is completed. I got the HELOC after I purchased the home (if that makes a difference). Thank you in advance for any help/advice you can give.

It will be interesting if Countrywide accepts your deed in lieu if you have a heloc secured by the same property with a different lender.  Most lenders will not accept a DIL if there is another lien on the property.  

I bought a house in May of 08 and is my primary residence. If I have my house foreclosed or short sale do I still qualify for the mortgage debt relief act (no tax conseqences) for the loss. My house is worth $400K and I paid $529K. Do I have to live there for more than 2 years to qualify for the tax forgiveness? Thanks

I am going to make a new blog post with your question.

I have a client who has been working with Countrywide (not that they cooperate without) on a short sale.  She was waiting for approval of the sales price, but now has been informed that CW will not accept a short sale on non-owner occupied properties.  This was her primary residence, but moved out and rented the property in an attempt to avoid the unavoidable.

Has anyone else heard CW doing this?

Thanks for the info!!!

TJ I am creating a new blog post with your comment and my answer.