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TechGromit says

December 31st, 2012, the Mortgage Debt Relief Law expires. All of you deadbeats that walked away from your mortgage obligations will get your just due. Why do you think the banks have been stalling on foreclosing? They are waiting for the IRS to give you the shaft. Income over 100k is taxed at the 35% tax bracket. Housing peaked in California at a median average of 484k, now the median average is 244k. That's an 84k median tax bill that will be coming due in 2014, hope you saved all your pennies you dead beats.

The banks won't see a penny of that, so they don't care. Banks are not in the business of vigilantism. They didn't foreclose because it would have cost THEM money. They could care less if the IRS gets a dime.

It looks like this only applies to people that got principal reductions. How would this affect people that walked away & had the property repossessed? EDIT: Nevermind, it looks like it hits walk-aways, too (with certain criteria).

Comment taken outside by Superjet. View

Not sure why it was taken outside...there didn't seem to be anything controversial here.

The people in California who both walked and didn't refinance will be fine since California mortgages for an initial purchase are non-recourse debt which doesn't turn into taxable income as long as you don't retain the collateral.

Many other Americans will be fine too since we're bad savers and forgiven debt is tax exempt up to the amount of our insolvency.

Debt also only becomes income when it's forgiven. A bank which forecloses or accepts a short sale on a recourse loan without waiving obligation on the deficiency can keep the debt on their books or sell it for pennies on the dollar without that happening.

So, HELOCs are counted as income when one defaults on them?

bmwman91 says

So, HELOCs are counted as income when one defaults on them?

Only

1) To the degree they exceed one's insolvency. Some one with a 400K first mortgage, 200K HELOC on a home now worth $300K and no other debt won't owe anything as long as their other assets are worth less than $100K. (Net worth = 300K in real estate + 100K in other assets - $600K in debt = negative $200K so one can add back $200K of forgiven debt before getting above zero and needing to pay taxes).

2) If and when the debt is forgiven instead of being kept on the books or sold.

So I take it that very few people are going to get hit with the "consequence hammer"?

bmwman91 says

So I take it that very few people are going to get hit with the "consequence hammer"?

I don't know about that. There was a hell of lot of refinancing and home equity loans going on during the boom. Many people refinanced several times in ever higher mortgages. A lot of the original non-recourse are recourse loans now.

I assume you are talking about current long term squatters. Those who walked and had the house foreclosed on between 2007 and 2012 will be exempt from the taxes as per the quoted law. It really is odd they passed this law, by the way. It was basically inviting people to stop paying and walk away as soon as possible.

lotr1978 says

It really is odd they passed this law, by the way. It was basically inviting people to stop paying and walk away as soon as possible.

From what I can see, it brought parity to homeowners and investors. You can't deduct a loss on your primary residence but you can do so if it is an investment property. For example...

Joe Schmoe buys a house for $200k. He gets foreclosed on when it is worth 100k and the bank forgives 100k. ZAP - 100k in 1099 income (prior to the current law).

Joe Investor buys a house for $200k and rents it out. Leaving depreciation out of the equation and other things ... the house drops in value 100k, bails out, and the bank forgives 100K. He gets the 100K in debt forgiveness income but can deduct the difference in his purchase price and the value when it was "sold" as a loss.

This example is a little simplistic and I'm sure there are more variables in life but that's more or less how it works as far as I understand.

I see, but the investor will be claiming that 100k loss at 3k per year for 33 years won't he? I didn't think you could offset your entire yearly income.

lotr1978 says

I see, but the investor will be claiming that 100k loss at 3k per year for 33 years won't he? I didn't think you could offset your entire yearly income.

I'm not a tax guy but I believe you are talking about passive losses which you can offset with passive gains so no I don't think the 3K per year rule would apply in general. I do know that if the loss is inside an LLC (been there, done that) the income and loss get worked out before you get issued a K1 which is when the passive loss rule gets looked at unless my CPA cooked the books.

I'm sure someone more versed in tax law can speak up.

EightBall says

Joe Investor buys a house for $200k...

I'm pretty sure the current debt forgiveness law only applies to owner/occupiers of property, even if they buy a 4 unit building and live in one of the unit they qualify. Investors in property that isn't the primary residence foreclosed on would be issued a 1099 from by the bank and be responsible for the taxes to the IRS. There is also a dollar limit, 1 million single and 2 million married. So if millionaire Joe buys a property for 10 million, get foreclosed on and it's sold for 5 million, Millionaire Joe gets a 5 million dollar 1099 from the bank.

TechGromit says

So if millionaire Joe buys a property for 10 million, get foreclosed on and it's sold for 5 million, Millionaire Joe gets a 5 million dollar 1099 from the bank.

You still don't get it.

If Investor Millionaire Joe bought an investment property for 10 million he has a 5 million loss which offsets the 1099 in your scenario. There are other issues (depreciation/recapture) but setting those aside he has a business loss of $5M.

Before the current law, Homeowner Joe Sixpack buys a house for $200,000, gets foreclosed and gets a $100,000 1099 and has no way to offset it (assuming a recourse loan). It actually sucks for him if he put money down - that is money that he can't call a loss like the investor can do.

I don't see why everyone thinks the debt forgiveness act (or whatever it is called) is unfair as it basically treats homeowners the same way investors are treated when their asset drops in value.

EightBall says

You still don't get it.

If Investor Millionaire Joe bought an investment property for 10 million he has a 5 million loss which offsets the 1099 in your scenario. There are other issues (depreciation/recapture) but setting those aside he has a business loss of $5M.

You right I don't. If Joe millionaire purchased the investment property for 10 million CASH, and sold it for 5 million, yes, he lost 5 million dollars and claim those losses on his taxes. But if he uses a loan from the bank to buy the property, how can he claim losses when he didn't lose any money, it was the bank that took the 5 million in losses. If he put 20% down, (ie 1 million dollars) he could claim the 1 million dollar loss, but not the loan amount. You'll have to give me a link to prove your position, I can't see it.

TechGromit says

You'll have to give me a link to prove your position, I can't see it.

http://www.irs.gov

The bank doesn't purchase the property. The investor does and it doesn't matter if he uses cash or money borrowed from a bank or Obama's stash. They are two distinct transactions. If the bank "forgives" a loan, a 1099 is issued. If the investment property lost value, he has a loss he can claim upon disposal of the asset. So Joe Millionaire gets a 1099 for cancellation of debt (shows as income) but turns around and claims the loss on the property (assuming it is disposed of either through sale, foreclosure, nuclear strike, or whatever).

My point is that the debt forgiveness act gives a "similar" benefit to a homeowner that an investor already has and will probably have forever. This was never a problem for a homeowner until the housing market tanked as "homes always go up in value - buy now before you are priced out of the market!"

This sort of reminds me of Chrysler ads back a few years ago. You could get a cheap lease..real cheap..but the final payment of it was easily at least 5x-8x a regular payment. If you don't pay it then they repossess the car and of course it probably acts as a R9 chargeoff.

I've been following this too. Once it ends in 2012
the number of walkaways will drop like a rock.

banks could be waiting for that to ensure that unloading foreclosures doesn't creating a ripple effect. As a side benefit the deadbeats who are squatting get hit with a massive tax bill.

win-win.

drew_eckhardt says

The people in California who both walked and didn't refinance will be fine since California mortgages for an initial purchase are non-recourse debt which doesn't turn into taxable income as long as you don't retain the collateral.

But that doesn't help people who refied with cash out or who took out 2nd or 3rd mortgages after the initial purchase and didn't use it for the house. Read IRS publication 4681 if you have additional questions: http://www.irs.gov/pub/irs-pdf/p4681.pdf

bmwman91 says

So, HELOCs are counted as income when one defaults on them?

Yes, if they are not put back into the house.

EightBall says

I don't see why everyone thinks the debt forgiveness act (or whatever it is called) is unfair as it basically treats homeowners the same way investors are treated when their asset drops in value.

No, it doesn't. When you get a mortgage, you are getting cold hard cash. Cash does not drop in value. When your indebtedness is written off, it's nothing like a regular investment asset dropping in value. [N.B. See criticism below and my explanation. Inflation is another issue. I'm saying that $1000 cash is literally $1000 cash even 20 years later.]

Do you really think they won't extend it? Has anybody seen any will from the California and Federal government to not pretend and extend the housing bubble?

actually they probably wont extend it. Since it takes about 6 months to do a short sale. Starting about 6 months from now anyone who forecloses or short sells their house is at risk of seeing a massive tax bill.

corntrollio says

No, it doesn't. When you get a mortgage, you are getting cold hard cash. Cash does not drop in value. When your indebtedness is written off, it's nothing like a regular investment asset dropping in value.

Yes it does.

corntrollio says

Cash does not drop in value.

My laugh for the day.

While I'd love for the Consequence Hammerâ„¢ to come crashing down on everyone, Congress will likely step in and extend the bill.

The timing of foreclosure sales has nothing to do with the tax consequences to a borrower of forgiven debt. Foreclosure sales are timed to maximize the tax consequences to the foreclosing banks.

The bank takes a gain or loss on its loan at the time of the sale ---- these day, usually a loss. The loss is calculated from the amount of the bank's credit bid. If a bank makes a "full" credit bid for the property, ie., the amount of its unpaid loan, the bank is deemed to have been paid the loan in full even if the house it received as "payment" is worth much less. Only upon REO resale of the house does the bank take the loss.

Alternatively, if the bank bids less than the unpaid balance of the loan, it can take a loan loss at the time of sale equal to the difference between the unpaid balance and the amount of its credit bid for the home.

BTW, this is how banks are using foreclosure sales to hide their losses. They are bidding more for their foreclosed homes than they are worth, thereby delaying the ultimate loss to later quarters. It helps them pay larger bonuses this quarter and helps the regulatory agencies by making it appear the losses are small this quarter and the housing market appear to be stabilizing.

The loss is calculated from the amount of the bank's credit bid. If a bank makes a "full" credit bid for the property, ie., the amount of its unpaid loan, the bank is deemed to have been paid the loan in full even if the house it received as "payment" is worth much less.
goodrich, I'd been wondering about this; thanks for the thoughtful analysis. In the case that a third party buys the house at auction for less than is owed, does the loss get recorded differently on the banks books if the owner gets a 1099 (which is what Debt Forgiveness is all about). Or is the 1099 immaterial (to the bank, of course)?

goodrich4bk says

If a bank makes a "full" credit bid for the property, ie., the amount of its unpaid loan, the bank is deemed to have been paid the loan in full even if the house it received as "payment" is worth much less.

So, you are saying, if I owe $200k, the house is worth $100k, and the bank bids $200k the borrower has no 1099 cancellation of debt income? Pretty sure that isn't how it works so you must be talking about the bank-side of the books.

joshuatrio says

My laugh for the day.

It is quite obvious that I'm not talking about inflation in this case, but rather a comparison to asset values and based on taxation issues. Context, people. The point is that cancellation of debt income is absolutely not the same as asset values dropping.

corntrollio says

The point is that cancellation of debt income is absolutely not the same as asset values dropping.

It is not exactly the same but you fail to see the big picture. On a bottom line basis, without this act that everyone so gleefully hopes will not be renewed homeowners are screwed on their taxes in a way that an investor in a similar asset (i.e. a house) in a similar situation is not.

Really, if you think landlords are such scum I don't know why you are shilling so hard for them.

StoutFiles says

While I'd love for the Consequence Hammerâ„¢ to come crashing down on everyone, Congress will likely step in and extend the bill.

Either that, or write a new one that does the same thing in regards to those who walk away. The economy needs people spending, not enslaved to a tax burden so that all their income above the poverty level is taken in taxes.

just the possibility that they might not extend it means the number of short sales and NODs will likely drop off a cliff in 2012.

EightBall says

It is not exactly the same but you fail to see the big picture. On a bottom line basis, without this act that everyone so gleefully hopes will not be renewed homeowners are screwed on their taxes in a way that an investor in a similar asset (i.e. a house) in a similar situation is not.

Still not a similar situation, and you're the one missing the big picture. The only way to make it a similar situation is to have the investor leveraged. In that case, both parties would be in exactly the same position. If the brokerage wrote off the margin account, then it would be cancellation of debt income, just like for housing. Otherwise, no, it's absolutely not the same situation.

corntrollio says

Still not a similar situation, and you're the one missing the big picture. The only way to make it a similar situation is to have the investor leveraged. In that case, both parties would be in exactly the same position. If the brokerage wrote off the margin account, then it would be cancellation of debt income, just like for housing. Otherwise, no, it's absolutely not the same situation.

You obviously don't understand what I'm saying. Take the leveraged situation out of both sides:

Joe Homeowners buys a house for $200k in cash. He later sells it for $100k. He just blew $100k on nothing and can't deduct the loss on his taxes.

Joe Investor buys a house he intends to rent for $200k in cash. He later sells it for $100k. He just blew $100k on nothing but can deduct the loss on his taxes as a consolation prize that Joe Homeowner doesn't get.

Add the leverage back:

Joe Homeowner convinces a bank to loan him 100% on a $200k house. For whatever reason he stops paying and is foreclosed and the 1099 shows the FMV as $100k and is issued $100k in COD income. Before the law, he was stuck with $100k in COD income that he had to pay taxes on.

Joe Investor convinces a bank to loan in 100% on a $200k house he is going to rent out. For whatever reason he stops paying and is foreclosed and the 1099 shows the FMV as $100k and is issued $100k in COD income. Lucky for him, he can claim $100k in loss offsetting the COD income and pays zippo in taxes on the COD income.

The debt forgiveness law allows the leveraged homeowner to not pay taxes on the COD income - in a similar way the investor doesn't have to pay taxes on the COD income due to the ability of writing off the decline in value.

I don't see why you have such a problem understanding this.

EightBall says

Joe Homeowners buys a house for $200k in cash. He later sells it for $100k. He just blew $100k on nothing and can't deduct the loss on his taxes.
Joe Investor buys a house he intends to rent for $200k in cash. He later sells it for $100k. He just blew $100k on nothing but can deduct the loss on his taxes as a consolation prize that Joe Homeowner doesn't get.

I believe I missed where you said that they were buying similar assets -- I was obviously talking about where they buy different assets. Nonetheless, you are talking about two different situations. The primary homeowner also pays no taxes if the house price goes up to $300K. The investor does. Should we eliminate that loophole too?

Rental properties have different basis rules than primary residences too. The passive loss activity rules also apply to the investor, so he/she can't deduct that whole amount all at once generally, unless he/she is also a real estate professional. Furthermore, if the debt is non-recourse, there is no COD income in either case.

You also can't talk about taxes without talking about timing. The foreclosure of the house triggers the loss with respect to housing value. However, if the debt is recourse, then the COD income doesn't occur until the bank writes off the debt. This can occur in different tax years.

It's like arguing that a 401(k) and a regular taxable investment account have different rules. Duh, they do. Furthermore, trying to make a principled taxation argument out of something that is largely political in nature (such as eliminating taxation on COD income in this scenario) is also somewhat difficult and can have pitfalls.

What about this hypothetical scenario:
Joe Homeowner has basis in a house of $100K. His loan is $300K because he did a cash-out refi during the housing boom. House sells at foreclosure for $150K. Homeowner has $50K in taxable income that is exempt from taxation. Homeowner has $150K of COD income.

Joe Investor has basis in a house of $100K. His loan is $300K because he did a cash-out refi during the housing boom. House sells at foreclosure for $150K. Investor has $50K in taxable income from the sale of the house. Investor also has $150K in COD income.

Should we still eliminate COD income for Joe Homeowner in this scenario?

What about this hypothetical scenario:
Joe Homeowner has basis in a house of $200K. His loan is $300K because he did a cash-out refi during the housing boom. House sells at foreclosure for $175K. Homeowner has $25K in loss that is not deductible. Homeowner has $125K of COD income.

Joe Investor has basis in a house of $200K. His loan is $300K because he did a cash-out refi during the housing boom. House sells at foreclosure for $175K. Investor has $25K in potentially deductible loss from the sale of the house. Investor also has $125K in COD income.

Should we still eliminate COD income for Joe Homeowner in this scenario? The problem is that you conveniently picked offsetting numbers, but that gave you an inconvenient example. What about when it doesn't offset?

This is all hypothetical which is why I picked offsetting figures to illustrate the difference because it is easy to understand. I also threw out depreciation, carry-over passive loss, etc, to show how an investor is treated tax-wise that a homeowner is not attempting to keep it simple.

Whoever used the house as an ATM deserves the COD income in any case because that money didn't (in general) go back into the property.

corntrollio says

The passive loss activity rules also apply to the investor, so he/she can't deduct that whole amount all at once generally, unless he/she is also a real estate professional.

They can and do offset the COD with the loss. If you think about it, how can the gain be classified differently than the loss in the same situation/transaction? It is the same and it certainly will offset it. Whether or not it happens in the same tax year is somewhat immaterial as the bank waiting just pushes it out into the future. On a specific case it may matter in but in general it is a wash.

All thing aside, cashout REFI, if I understand correctly, isn't covered by the debt forgivenes law. I'm sure there are some nuances to it but someone that was bought-and-caught by the crash is eligible and a refi-ATM scumbag is not.

corntrollio says

The primary homeowner also pays no taxes if the house price goes up to $300K. The investor does. Should we eliminate that loophole too?

I don't see why this provision is there in the first place. The trade-up rule covered people moving up already (similar to 1031 exchange, if I have the number right) and this really only helps the two-year flipper and empty nesters downsizing.

EightBall says

I don't see why this provision is there in the first place. The trade-up rule covered people moving up already (similar to 1031 exchange, if I have the number right) and this really only helps the two-year flipper and empty nesters downsizing.

I don't either, but it is very popular, both politically and among the general populace. However, it is the flipside of having COD income if the value goes down -- gains are not taxable unless they are greater than $250K for single/$500K for married. That is a huge loophole.

Anyway, the main point is that homeowners and property investors are treated completely differently by the tax code already. Trying to make this particular aspect consistent in a limited number of scenarios (but not others) does not really add that much robustness to the current system.

It's not really unprincipled to treat business homeownership and personal homeownership differently. We do this with other things in other parts of the tax code. For example, interest on business debt is now treated differently than interest on personal debt. All interest used to be deductible under the tax code back in the day, regardless of whether it came from personal debt or business debt. However, it used to be that we weren't such a debt-riddled culture, so that there wasn't that much personal debt (i.e. credit cards and auto loans), and the mortgage culture was different too (until the secondary mortgage market was created largely by the government, we used to have loans with bubble payments -- this was a big driver of the Great Depression in some ways). The main interest people might have paid was business interest on business debt and interest on people's mortgage. After Reagan's changes in 1986, we eliminated all deductions on personal interest, and we kept mortgage interest deductible because it was politically popular and perhaps there is some historical antecedent. That's also why we have a misguided cap on student loan interest, all of which should probably be deductible if we're going to maintain the mortgage interest deduction.

corntrollio says

It's not really unprincipled to treat business homeownership and personal homeownership differently.

I agree with you but the debt forgiveness act is not there to let ATM-cashout morons off the hook which I think is the misconception. For most people their house WAS an investment (right or wrong) and the forgiveness act reflects this in my opinion. Like I said at first, it simply treats a homeowner in a similar manner that it would treat an investor when it comes to housing. It isn't some ludicrous "you ATM'ed a lot of money and you are off the hook" act. That would be wildly different.

EightBall says

I agree with you but the debt forgiveness act is not there to let ATM-cashout morons off the hook which I think is the misconception. For most people their house WAS an investment (right or wrong) and the forgiveness act reflects this in my opinion. Like I said at first, it simply treats a homeowner in a similar manner that it would treat an investor when it comes to housing.

I don't think you even have to consider the cash-out refi people. The reality is that even people who were paying purchase money via a loan were making stupid purchases at bubble pricing. It's not too difficult to say they should suck it up, especially since some of them were previously homeowners that received a windfall by selling their previous house during the bubble. If you are motivated by the bubble to buy a house, you assume the risk. If they had managed to flip the house before the bubble ended, they would have gotten a huge tax-free gain. Speculation works both ways.

Don't worry everyone. Congress will extend the law so that those who get foreclosed on don't have to pay taxes. Nothing to see here.

you really think this will get extended?