For many months now, we’ve been monitoring the FIT situation for underwater mortgages, as well as those homeowners facing foreclosure, regarding Florida short sales and the current income exclusion from federal income taxes.  In short, back in 2007 a law was passed that excluded any write-off, or forgiven debt, in a foreclosure, short sale, or mortgage loan modification, from being considered taxable income.

Florida Short Sale Tax Exclusion May Fall Off the Fiscal Cliff

That’s right: without this law in place, the amount that was left on the underwater mortgage — the deficiency — would by definition be taxable income for the homeowner.  No, you didn’t see any money in your pocket, but that is how the IRS would count that deficiency write off if the forgiven amount wasn’t protected by that specific tax law.

Now, of course, we’re reading all about the “fiscal cliff.”  It’s complicated.  One thing is clear: this deficiency exclusion is part of the fiscal cliff.  If the tax law isn’t extended, it dies by its own terms on December 31, 2012.

Larry Tolchinsky’s Tip:

It may seem screwy: you don’t see a dime in your pocket, but the IRS counts the write-off as income on your income taxes. Gotcha!

Fair or not, that’s the situation.  For people with underwater homes, dealing with banks for loan modifications, short sales, or a foreclosure, they are already in financial hardship and having any write off or debt forgiveness suddenly counted as a Big Windfall for them, income-wise, is just plain sad.

There’s an old saying about kicking someone when there down that comes to mind, right?

Florida Attorney General and 41 Other State Attorney Generals Push Congress to Extend the Tax Law for Florida Homeowners

So, what is going on to stop this?  Well, Florida Attorney General Pam Bondi signed a letter (read the letter here) along with 41 other state Attorneys General, asking Congress to extend this consumer tax relief. From her news release:

“We are urging Congress to protect distressed homeowners who qualify for mortgage relief from encountering an unexpected tax bill from the IRS,” stated Attorney General Pam Bondi. “This tax relief is critical in helping Floridians keep their homes and get back on their feet.”

Congressional Bills Moving Through House and Senate: No FIT Extension for Distressed Homeowners Done Yet

In Congress, there are two bills moving through the House of Representatives that would extend the tax exclusion – if they end up passing the House, the Senate, and get President Obama’s signature okay.  They are Resolution 4336 and Resolution 4202.

H-4202 would extend the exclusion through 2014, for “income attributable to the discharge of indebtedness on a principal residence,” and H-4336 would do the same, but only through 2013.

In the Senate, S-2250 asks to extend the overall exclusion through 2014 while S-3224 asks for it to be extended through 2015 for “discharge of indebtedness of a principal residence.”

It’s a mess.  There’s only a few weeks left before the deadline.  If some version of these bills aren’t passed before Congress leaves Washington for the holidays, then Florida short sales and foreclosures and those Florida underwater homeowners are going to face having to pay an income tax on the dollar amount that the bank writes off or forgives on the mortgage.  If you read through the various bill’s history, you’ll see they’ve been floating around up there for months without anything getting passed.

It’s scary stuff.

Lesson here: Florida short sales need to close before year end if at all possible. Having a Florida real estate lawyer experienced with short sales to help you close that deal can make a big difference here.  Not only will the Florida lawyer know your bank’s reputation for delay tactics, conditions, etc., but there may be past experiences with people at the banks themselves that can help close a short sale because the lawyer knows what to expect from the other side.  Short sales can get done between now and December 31, 2012, but only if you are on the offense to get the short sale done and insure you get that deficiency income tax exclusion.

Do you have questions or comments? Then please feel free to Chat with Larry in the comments below, at info@hallandalelaw.com, or (954) 458-8655.  If you have a specific situation, please call or email Larry because he can’t answer specific fact questions in general comments.  He’s happy to take your call.