I have been getting a lot of calls and emails about the Mortgage Forgiveness Debt Relief Act of 2007.  The new law became effective today, and applies to 1099's on short sales or foreclosures retroactive to January 1, 2007.

Before the Act was passed, one of the rewards for a homeowner helping the lender keep the home out of foreclosure and minimizing the enevitable monetary loss to the lender, was that the homeowner at the end of the process was saddled with a huge income tax bill compliments of a Form 1099 unearned income statement.

For detailed information and the text of the bill, see my blog at Mortgage Forgiveness Act of 2007.

An interesting question raised relates to situations where the mortgage being shorted or foreclosed is a refinance of the original mortgage used to purchase the property.  It is the ORIGINAL indebtedness that qualifies for the non-recognition of income treatment by the IRS under the Act.  Can any portion of the new mortgage not being repaid qualify for the non-recognition treatment?

The language of the Act says, "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."

I take this to mean that if the original loan to acquire the prinicpal residence was $150,000 (and was not materially reduced) and that loan was refinanced to $200,000, and then the house is short saled at $125,000 (leaving $75,000 of potential income recognition to the seller), then (a) the top $50,000 would not be qualified under the Act, and (b) the bottom $25,000 of the unpaid mortgage would be entitled to non-recognition of income treatment.

No guidance has not yet been issued by the IRS, but my feeling is that this will be the way it ends up. 

My feeling is that the Act will do nothing to quell the precipitous drop in house values in many areas.  If anything, it may actually accelerate the number of homes that become available for short sale because one of the reasons for not short selling a home has been removed from the consideration equation.  The Act gives tax relief and likely will avoid a lot of bankruptcy filings - and may also help in getting these same sellers ready for re-qualification for purchase of a new home sooner than later -- had they a big IRS tax lien hanging over their heads under the law as it existed prior to today.

Let's watch for developments and IRS guidance on this subject.  In the meantime, Realtors should use this knowledge to expand listing to include those sellers that were sitting on the fence - afraid of the residual bad taste of the 1099 as their reward for the short sale process working for the lender.

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