The American Taxpayer Relief Act of 2012 was passed late in the evening on January 1st and was quickly signed into law by President Obama. While much of this contentious Bill was disappointing to all and, in effect, kicked the can down the road for more negotiations in the months to come, reading through the Act reveals a blessing for upside-down homeowners.

When a homeowner experiences a debt reduction through mortgage principal forgiveness – such as through short sale, foreclosure, or even loan modification – the amount of debt forgiven is considered taxable income. In 2007, Congress passed the 2007 Debt Forgivess Relief Act which exempted up to $2 million of debt forgiven on the homeowner’s principal residence as long as the debt was used to buy, build, or substantially improve their principal residence and be secured by that residence. The Debt Forgiveness Relief Act has been an incredibly valuable tool in helping opur nation’s real estate industry recover. However, the Act which was passed in 2007 had a 5-year sunset provision and was set to expire on December 31, 2012. The American Taxpayer Relief Act of 2012 exended the sunset provision until Jan. 1, 2014.

For the real estate industry and for upside down owners, especially those with short sales pending, the signing gave sellers a sigh of relief knowing that they won’t get slammed with taxes and they can move on with their lives. But it is critical to remember that there is a deadline that will get here all too soon. In any transaction where there will be debt forgiveness – such as a foreclosure, short sale, deed-in-lieu, or even a loan modification – there will be the chance that the amount forgiven will result in taxable income unless they have an exemption. While the Act is only one of several possible tax exemptions, it has been the most widely used exemption and in many cases the only exemption that applies. We do not expect that the Act will be extended beyond December 31, 2013. The result is that if you are going to have a real estate transaction in which there will be debt forgiveness, you must get it completed and recorded no later than December 31st.

In the current real estate market, we are seeing short sales getting completed in four months or less. Loan modifications, if they occur at all, are often taking many months and it is too soon to tell if California’s Homeowners Bill of Rights will accelerate this process or cause the reverse if lenders decide to reject loan modifications at all. Foreclosures are the most at risk. In California the average time from stopping paying to foreclosure sale is at least 10 months (although it could potentially be less and often is much longer). What this means is that if someone were to stop paying their mortgage in March, a foreclosure might not occur until 2014 and therefore any forgiven debt would be taxable income. Ouch!

The message from this is that if you are having problems with your real estate loans, don’t wait. Get advice quickly so that you will have time to act and chhoose your best financial path.

If you or someone you know is facing a legal or financial challenge and don’t know what to do, our BPE Law flat fee Consultation Program can offer knowledge of what to expect and form strategies to achieve your best overall resolution. To schedule a Consultation, please contact our office at (916) 966-2260 or e-mail me at sjbeede@bpelaw.com

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are upside-down on your loan, especially if you’re facing a lender lawsuit, get competent legal advice in your State immediately so that you can determine your best course of action.