There are rumors around Washington that the Mortgage Forgiveness Debt Relief Act of 2007 (MFA) will be extended yet again. Such an extension would be very good news to our improving real estate market for a variety of reasons; however, this year more than ever, I feel that it is imperative that agents recognize what the MFA actually means.
A very large number of agents still to this day are under the impression the extension of the MFA means “a seller can do a short sale and not have to pay tax on forgiven amount.” Well, one would think that is what it means, but that is a gross misconception and it does not apply to all.
The True Nature of the MFA
The fact of the matter is that an extended MFA would apply to, at my estimation, to less than 25 percent of the people who need to do a short sale in 2014. Simply put, the MFA only applies to forgiven debt on money that was used to “buy, build or substantially improve your principle residence.” It does not apply to forgiven amounts (by the short sale lender or through restructuring) that were part of a refinance or HELOC that increased the initial balance borrowed to purchase the home.
For example, a party that may have refinanced their home multiple times since initially purchasing, and used the money for anything other than “substantially improving” the principal residence, will not qualify under the MFA. So paying off a car, paying property taxes on the home or paying for tuition would not qualify under the MFA.
The simple fact is that a very large percentage of parties needing to do a short sale today have cashed out and refinanced multiple times, and therefore have larger balances than when they first bought their home with. So those folks will not qualify under the MFA – but interestingly enough, what most agents really don’t know is that there are other options in the tax code that they may qualify for.
Misinformation on the MFA
The reason I am so passionate about this topic is because our clients know we are not CPAs or attorneys, but still ask us such pressing questions. I do have all my client’s sign a disclosure, which states that they understand I am only a real estate broker, and I only play an attorney and CPA on TV.
But with all that said, we repeatedly tell them we cannot give them advice on the subject matter, but we all know that in a roundabout way they press on. They say, “I won’t hold you to it, but the MFA did get extended, right?” You answer yes, it may. Many potential new clients – the vast majority, even – will assume that an extension means they won’t have to pay tax on the short sale. But here is the problem with that simple “yes” answer – 85 percent of the agents I surveyed for this article on a two-question MFA sample questionnaire got at least one of the questions incorrect, regarding whether their short sellers would or would not qualify for the MFA.
The truth is, we are not licensed to give out that information anyway, but answering “Yes, it may be extended” can easily be interpreted that you implied they qualify. Especially if you, as their broker, also think that they qualify.
Other Options for Distressed Homeowners
But here is the good news – a large portion of the people that do not qualify for the MFA may very well qualify for other tax provisions, such as insolvency. Insolvency is not to be confused with bankruptcy. So what is insolvency? Simply, a state of having liabilities that exceed assets.
So for example, a short seller may not have qualified for the MFA, but their liabilities at the time of the short sale may have exceeded their assets (i.e. They have more debt than they are worth at the time of the conclusion of the short sale). Therefore, they very well might qualify under insolvency and not have to pay the tax on the forgiven debt. But clearly, such a scenario is very complex, and it will not apply to every short seller that did not qualify for the MFA. The short sale lenders do not solely approve short sales to people that have a negative “net worth.”
I would advise any broker doing a short sale to have a go-to CPA (not an attorney) who knows the ropes of the MFA and insolvency. Not all accountants know the particulars, and if you tell your clients to call anyone, they might call their Aunt Louella who was a CPA, but who may not be up to par on what is going on here in 2014.
I would strongly urge brokers, when asked if the MFA got extended, to answer in such a way: “It may get extended, but you very well may not qualify for the MFA. Only a CPA (not an attorney) that is very well versed with the MFA, and the current tax codes, can properly tell you what you will qualify for, including possibly insolvency, but this is all something that needs to be discussed with a truly qualified CPA well versed in real estate tax.”
The extension of the MFA to me still has a lot to do with perception. If struggling homeowners perceive the MFA can help them, and reaches out to us, even if they may not qualify, they have made the call and you have the power to guide them to a better future.
Bert Gor is the president of The Short Sale Group, Inc. with RE/MAX Professionals Select. He has been recognized as a top producing short sale agent with RE/MAX Northern Illinois and has also been ranked in the prestigious RE/MAX Top Five of all Northern Illinois agents in recent years.