On Thursday the President signed into law - effective New Years Day, the Mortgage Forgiveness Debt Relief Act of 2007.

For those of you that aren't up to speed on the downside of a short sale, if the bank lends you $100 and you end up only having to pay back $75, then by keeping the $25 you have to declare that $25 as ordinary income.  You see, borrowing money is not taxable as income.  But if you don't have to pay it back, then it is no longer a loan, and instead it is income, just as if you (oh my gosh!) worked for it.

This new law is not going to give relief to flippers that have flops, or investors that over financed, or even homeowners that leveraged up their loans after acquiring the house.

THE NEW LAW ONLY APPLIES TO (1) PRINCIPAL RESIDENCE [A PRINCIPAL RESIDENCE IS ONE THAT "has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more"] and (2) LOANS THAT WERE USED TO ACQUIRE THE PRINCIPAL RESIDENCE [`qualified principal residence indebtedness' means acquisition indebtedness]. To quickly answer the first question you will have - which I imagine is, "what if there is a new second but the original first?", the answer is that the law does not apply to the portion of any indebtedness that exceeds the amount of the original acquisition indebtedness. ["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."]

This new law should give those to whom it effects a tremendous incentive to short sell their principal residences where they are upside down and the mortgage can no longer be serviced.  It will also encourage those with both a principal residence that is upside down and other properties to short sell the principal residence and move into the other residence.  The law is good until 2011 which gives multiple property owners the ability to hop home to home (if they can stay out of foreclosure) and still meet the 2 year residence requirement on the other residential property.

At the bottom of this Blog are partial texts of the relevant portions of the legislation, with links to the full text.

Have a wonderful holiday weekend!

Richard Zaretsky, Esq., RICHARD P. ZARETSKY P.A. ATTORNEYS AT LAW, 1655 PALM BEACH LAKES BLVD, SUITE 900, WEST PALM BEACH, FLORIDA 33401, PHONE 561 689 6660  RPZ99@FLORIDA-COUNSEL.COM - FLORIDA BAR BOARD CERTIFIED IN REAL ESTATE LAW - We assist Brokers and Sellers with Short Sales

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Partial text of the Act: 

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.

(Full Text - Foreclosure Relief Act )

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Definition for Principal Residence: such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more. - definition in Section 121 Internal Revenue Code (Definition of Principal Residence by IRS)