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The Mortgage Debt Relief Act – What Every Agent Needs to Know

by Bert Gor

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Bert Gor is the president of The Short Sale Group, Inc. with RE/MAX Professionals Select.

If you are in real estate, you probably know that the Mortgage Debt Relief Act of 2007 is due to expire at the end of this year. Regardless of whether you do a lot of short sales or just a few, the expiration of the Mortgage Debt Relief Act is a big deal. In the last few months, I have personally been told by Bank of America, Wells Fargo, Citi Mortgage and BMO Harris that short sales must close by the end of the year because of the Act expiring. The fourth quarter of 2012 will be my busiest fourth quarter in the last 10 years, and I can definitely attribute this in correlation to the Mortgage Debt Relief Act expiring.

Although, even after five years of the Mortgage Debt Relief Act having been around, there is still a lot of misconception among real estate agents (not to mention homeowners) what it really means and how it applies to a short sale seller. In my personal research, over 95 percent of real estate agents that I have spoken to are under the assumption that once the Mortgage Debt Relief Act expires, a short seller will be forced to pay income tax on the forgiven amount (gain) when they perform a short sale.  Well, if you are one of these agents, I have very good news for you; so please, let’s continue.

Some Perspective on the Mortgage Debt Relief Act Expiration

Having personally closed hundreds of short sales, I set out to help homeowners sell their homes and guide them to be in a better place than when I first met them. I want them to avoid foreclosure and bankruptcy all together, and most importantly, for them to never walk away. Yet, in the last few years, over 80 percent of the short sellers I worked with would not have had to pay income tax (gain) on their short sale had the Mortgage Debt Relief Act been non-existent.

What is critical to understand (note: I am not an accountant and I don’t play one on TV either) is how the “loss” and “gains” of a short sale actually play out. So let’s look at some easy numbers:

  • The Mortgage Debt Relief Act currently protects a primary resident homeowner from having to pay tax on the “gain.”  The gain is the amount that lenders report to the IRS as the forgiven amount via a 1099.
  • However, what most real estate agents don’t realize when selling real estate for less than what one purchased it for, is that there is also a “loss.”  So for example, if seller Todd bought a home in 2007 for $300,000, made a down payment of 10 percent and therefore borrowed $270,000, then had to short sale for $200,000 in 2012, he would have experienced a loss of $100,000.
  • Therefore, if the lender forgave Todd the difference between what he owed on the home ($270,000 minus five years of payments), to what the home sold for, it would equate to roughly a $70,000 gain to Todd (meaning, 270,000 minus 200,000). The gain is what would come to Todd in a form of a 1099. But, since the $100,000 loss is larger than the $70,000 gain, the loss washes the gain and Todd would not have had to pay income tax on the forgiven amount.

Just last month, for instance, I closed a short sale at 4115 Teak Circle in Naperville. The homeowner had purchased the home in 2007 for roughly $2.7 million. I successfully sold it for $1,050,000. I was able to get the bank to forgive the seller more than $1 million (gain) between his first and second mortgages.  So the loss to the seller ($2.7M – $1,050,000) was about $1.65 million. Since the loss to the seller was larger than the gain of the forgiven amount, even if the home closed in 2013 and the Mortgage Debt Relief Act had expired, he would not have had to pay a tax on the sale.

The Necessity of Short Sales in Today’s Housing Market

I recognize that this is complicated. Clearly, the above examples will not apply to every short seller. I recently closed a short sale with a seller who had Wells Fargo as the lender. Since the time they purchased the home, to the time we short sold it, they had refinanced at least four times, and at the time of the sale, they owed nearly $125,000 more than what they had originally purchased it for. So in their case, had the Mortgage Debt Relief Act not been in place, they would have had to pay income tax on the gain.

However, what is critical for all of us to understand is foreclosure is never a better option. The consequences are far more severe with foreclosure than with a short sale. If a short sale lender is willing to forgive a seller more than $1 million, there is absolutely no reason anyone should ever even consider walking away from their home. Rarely are we faced with homeowners that are looking to do a short sale where they need the lender to forgive more than $1 million in debt.

In my professional opinion, we as Realtors are the doctor’s in real estate. Although many Realtors are practicing selling short sales, many do not have adequate knowledge about the process. As a real estate agent practicing short sales, you must educate yourself with not just the overall process, but know what the fundamental differences are between all the different lenders, timelines and consequences. Clearly, I am not advising anyone to give legal advice, and furthermore, I would not recommend doing a short sale without an attorney. Although, using an attorney alone for the short sale process is not enough.

Also, an attorney will not give the homeowner tax advice. They will need to seek a tax professional. So you must have a tax professional in your arsenal that is familiar with the losses and gains within a short sale. Our sellers are counting on us to guide them through the short sale maze. We are the ones that work directly with the homeowner. They are counting on you to repair this real estate disease they have. Remember that you must have your facts straight, as you are about to perform open heart surgery on your sellers. I would never sell commercial, but I am licensed to do so. The same theory applies to short sales. We owe it to our sellers, and to the children of our sellers, to help guide them to a better future.


Bert Gor is the president of The Short Sale Group, Inc. with RE/MAX Professionals Select. In the last five years in a row, he has been the No. 1 ranked RE/MAX short sale agent in Northern Illinois and has also been ranked in the prestigious RE/MAX Top Five of all Northern Illinois agents.

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Comments

  • Jane ruddle says:

    My example… Not making the closing date by around jan 3….original loan 355. 3% down. Loan 343. After two years owe 335.. Short sale for 290….. Loss 65. Gain 45. Loss washes out gain..?

    What about the 24,000 I owe in non payments the last 8 months of not paying. Where does that fall into the equation.

  • Bert Gor says:

    Hi Jane:
    Thank you for your post. I am eager to try to help you.
    I would need to ask you a couple more questions to better assist you.
    When you refer to the “non-payments” over the last 8 months, you are referring to debt forgiveness from the lender, correct? As in, “what happens to those payments I did not make over the last 8 months”, correct? If so, we would need to refer to your approval letter. If the closing is to occur in the next week or so, you should already have an approval letter and someone should have reviewed the terms and or ramifications, if any, of the subject approval letter. An attorney is the one that should really be reviewing it with you, but if you care to share the approval letter I would be happy to read it with you. If the home is your primary residence, “most” lenders are forgiving the shortage. Please feel free to email to bert@bertgor.com and I would be happy to review it with you. Or you can call us at 630-615-2897.
    I stress to you that it is very important that the terms of the approval letter are reviewed with you PRIOR to closing. If they are not in your best interest, you may wish to go back to the lender and ask to see if they have any other options. If you have only missed 8 +/- payments, you still have time. Once you close, the terms cannot be changed.
    Bert Gor
    http://www.ShortSaleIL.com

  • Jane ruddle says:

    This is jane again. I am trying to retrieve approval letter to send to you. But in the mean time. After doing my math using your example above. My loss is 60,000 and gain either 50,000 or 40,000. (40,000 using current upto date paid mortgage after two years of payments). If I simply go off of your example does my loss wah out my gains? Thank you and happy new year. I am hoping for this answer to help give me a happy one too:). Thanks

  • Jane ruddle says:

    I spoke to mortgage company and as far as 8 months of nonpayment not included in current balance. Of 335,0000 owed. She said if I paid the 24,000 it would bring it down to 315,000 or so. Therefore my gain and loss figures are pretty accurate. I am asking if all figures are correct am I in the clear? Thanks again

  • Bert Gor says:

    ***UPDATE****1-2-12***The Mortgage Debt Relief Act, aka Mortgage Forgiveness Act, has been extend for 1 year! It expired on 12-31-2012, but has now been extend by Congress for another year! This is very good news for the Real Estate Market not just in Chicago, but throughout the country. Clearly, walking away is never a better option. Bert Gor, The Short Sale Group, Inc. http://www.Short SaleIL.com 630-842-6000

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