Ten Facts for Mortgage Debt Forgiveness from the IRS

IRS Tax Tip 2011-44, March 3, 2011

If you are a homeowner whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, you may be able to claim special tax relief and exclude the debt forgiven from your income.

Here are 10 facts the IRS wants you to know about Mortgage Debt Forgiveness.

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit http://www.irs.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments.

You can also use the Interactive Tax Assistant available on the IRS website to determine if the cancellation of debt is taxable. The ITA tool is a tax law resource that takes you through a series of questions and provides you with responses to tax law questions

Taxpayers may obtain copies of IRS publications and forms either by downloading them from http://www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

Form 982

Form 1099-C

Publication 4681

Banks Pay Delinquent Borrowers $35,000 For Short Sales

In an effort to cut their losses, banks are paying some struggling homeowners as much as $35,000 to sell their homes before they end up in foreclosure. The deals are aimed at incentivizing homeowners who owe more on their home than it is worth and who are seriously delinquent on their payments to sell their homes in a short sale.

In short sales, homes are sold for less than what is owed and the bank forgives the excess debt. Banks

have been reluctant to approve such deals in the past -- since they take a loss on the home -- but in certain cases, it's become a much better proposition than letting the homeowner fall into foreclosure.

This new approach by the banks has startled plenty of homeowners, according to Elizabeth Weintraub, a Sacramento-area real estate agent who specializes in short sales.

"Initially, the homeowners are skeptical," she said. "The bank may have already turned down their request for a modification. Then, one day, they call and say, 'Let us give you some cash.'"

When Chase Mortgage (JPM, Fortune 500) told Angelique Pierce, that she would receive a check for $25,000 if she sold her house, she couldn't believe it.  "I got the offer in the mail," said the Rancho Cordova, Calif. resident. "I called my bank to ask if it was real."

After Pierce became disabled a few years ago and had to stop working work, she fell behind on payments on both her first and second mortgages, valued at $250,000 and $50,000, respectively.

Now, she's trying to sell her three-bedroom ranch for just $95,000 -- almost half of the $179,000 she paid for the place in late 2002.

Foreclosure free ride: 3 years, no payments

From the bank's point of view, the offers make sense, according to Tom Kelly, a spokesman for Chase Mortgage, who would not comment on Pierce or other individual cases. "The first choice is a modification but if that's impossible than a short sale is a faster, more efficient solution," he said.

For the banks, foreclosure has become an increasingly difficult and expensive option. Homeowners have learned to fight the banks tooth and nail, dragging out cases for years.  

And as the cases drag, expenses grow. Homeowners not only stop paying their mortgages but they stop paying property taxes and conducting normal maintenance as well. Roofs, siding, plumbing and other parts of the home deteriorate and the property loses value. By the time banks take possession, they're out tens of thousands of dollars.

Foreclosures: America's hardest hit neighborhoods

"I've seen a lot of foreclosures for sale where it would cost a lot more than $20,000 to get them into condition to sell again," said John Hayton, a short sale specialist in Orlando, Fla, who has had a number of clients receive offers from the banks. 

Short sales also command higher prices than foreclosed homes. In December, foreclosed properties sold for an average of 22% less than conventional sales, while the discount for short sales was only 14%, according to the National Association of Realtors.  All that has been true for years, but it is only lately that these outsized incentives, which Bloomberg recently reported on, have surfaced.



Sellers are more cooperative when they're going to receive a five-figure check for their troubles.

Nick Chaconas, an agent with discount broker Redfin, wondered why one seller was so anxious to sell their home. "Since I represent the buyer, I didn't even know about the incentive until the closing," he said. 

It turned out that the seller's bank was writing her a check for $30,000.   Whether sellers can expect incentives from their banks depends on multiple factors, including where they live.
Wells Fargo (WFC, Fortune 500) limits its offers to certain states, such as Florida, where the foreclosure process can be lengthy, according to spokeswoman Veronica Clemons. The bank has paid $10,000 to $20,000 to borrowers who short sell or transfer their title to Wells via a deed-in-lieu.

What the foreclosure settlement means for you

Bank of America (BAC, Fortune 500) had a pilot program in Florida that paid incentives of $5,000 to $20,000 for sales that were initiated between Sept. 26, 2011 and Nov. 30, 2011 and close by the end of this August. The amount of the incentive is based on 5% of the unpaid balance, with a $5,000 minimum and $20,000 maximum. 

Jumana Bauwens, Bank of America's spokeswoman, called it a "test-and-run program" that may be expanded to other states.

The offers are not always a panacea for homeowners struggling to pay the bills, however.

Pierce, for example, has not been able to make hers pay off. She had a buyer but her second mortgage holder refused to go along with the deal unless it got a share of the $25,000 she was being offered by the bank. She said that the bank balked at the deal and the sale was cancelled.

She's looking for another buyer, but it's up in the air if Chase will honor its original offer if the second mortgage holder won't cooperate.

Homeowner's Help Hotline - Bloomberg

Mortgage Forbearance- A Break you Can't Afford?

Forbearance now has the backing of the White House, but lowering or halting payments for now may simply delay the inevitable. Weigh your options carefully.

By Liz Pulliam Weston - MSN

If you're struggling to pay your mortgage, your lender may offer you forbearance. Think twice before you take the deal.

Can you afford mortgage forbearance?

Forbearance is a lender-approved reduction or elimination of your payments for a short time, usually a few months. Until recently, lenders made forbearance offers voluntarily, often in response to a temporary financial setback, such as a layoff, and the deals typically required borrowers to catch up on the missed or reduced payments within a year.

Under the Obama administration's recently announced expansion of the Home Affordable Modification Plan, or HAMP, lenders in the program will be required to offer forbearance to unemployed homeowners for at least three months and in some cases up to six months. Payments must be reduced to 31% of borrowers' incomes.

The details:

• Homeowners must meet HAMP eligibility requirements, which include owner occupancy (no rentals or investment property), a loan balance below $729,750 and an origination date before Jan. 1, 2009.

• Homeowners must ask for forbearance.

• Homeowners can't be more than three months behind with their payments. (They can be current and request forbearance; they just can't be more than 90 days overdue.)

• Homeowners must provide proof they're receiving unemployment benefits.

If a homeowner finds a job within the forbearance period and her regular payments would exceed 31%, she must be considered for a permanent loan modification.

Most such modifications so far have involved reducing the loan's interest rate and/or extending the loan term up to 40 years, but the Obama administration is now offering incentives to encourage lenders to forgive portions of some borrowers' loans.

If borrowers who got forbearance don't qualify for a modification that includes a reduction of their principal, though, they're expected to pay back the difference between their reduced payments and their regular payments, said Brian Sullivan, a spokesman for the U.S. Department of Housing and Urban Development.

"These mortgage reductions are not forgiven," Sullivan said. "They are repaid unless the borrower qualifies for a principal write-down."

If borrowers don't find employment by the end of their forbearance, they may be considered for foreclosure alternatives such as a short sale (in which the lender accepts the sale proceeds as full payment for the loan) or deed in lieu of foreclosure (which allows a homeowner to hand back the house keys in order to avoid full-blown foreclosure).

If your situation isn't too dire, it's possible that forbearance -- either the kind lenders offer voluntarily or the kind required under HAMP -- could get you back on track financially. But forbearance might not work, and it could leave you even worse off.

Here's what you need to consider:

Forbearance typically hurts your credit. When you don't pay lenders what you originally owed them, they typically take their revenge by reporting you to the credit bureaus as making late or partial payments. That can trash your credit scores.

That's certainly been true for the forbearance that lenders have been offering voluntarily, as well as for loan modifications, and it's likely to be true under HAMP forbearance as well, said real-estate expert Ilyce Glink, the author of the book "Buy, Close, Move In!"

When HAMP was first announced, "we were told loan modifications wouldn't hurt people's credit," Glink said. That turned out not to be true, she said, and signing up for loan modifications "destroyed a million people's credit."

How much damage you might suffer depends on how high your scores were to start with, with higher scores taking bigger hits. That's why you shouldn't seek forbearance if you have other ways of paying your mortgage, such as tapping savings.

But you also should be realistic if you're in trouble, because every option that would save your wallet some pain is likely to inflict some damage on your credit history and credit scores, Glink said. Forbearance would certainly have less of an impact than losing your home to foreclosure.

Forbearance may not be enough. Unemployment can last a long, long time, particularly in this recession. Half of the people who are unemployed have been without a job for 19 weeks or more. Even if you should land a job, you still may not be able to afford your mortgage, and there are no guarantees a mortgage modification would help.

"The first question you should ask yourself is, should you be trying to save this house?" said Glink, who runs ThinkGlink.com, a personal-finance site. "Can you catch up? You may think keeping your house is your top priority, but should it be?"

Forbearance may just delay the inevitable. In fact, some housing experts say the real benefit of the HAMP expansions won't be in preventing foreclosures as much as delaying them, since spreading foreclosures out over a longer period may reduce their impact on the fragile housing market.

But if you're likely to lose your house in the end, you may want to stop throwing good money after bad. Instead of making lower payments, you may be better off financially simply making no payments, saving your money and trying to arrange a short sale or letting your lender foreclose.

That's a hard pill for many to swallow, and you shouldn't consider it until you've weighed all your options, as I wrote in "Are you foolish to pay your mortgage?" But if you're deeply "underwater" (owing far more than the house is worth) and your lender isn't helping with a permanent loan modification, letting the house go may be the best of bad options.

If you're struggling, you should:

• Get help. Talk to a HUD-approved housing counselor about your options. You can find referrals here. These counselors are free and are a far better initial option than trusting law firms or others who demand big upfront fees (and who may just sign you up with the same programs as the HUD counselor).

• Make the right decision for you and your family. That could mean fighting to keep your house with everything you've got. It could mean throwing in the towel. Or it could mean something in between. Whatever decision you make, you'll have plenty of company as millions of other homeowners face the same struggle.

Liz Pulliam Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "Your Credit Score: Your Money & What's at Stake." Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board and helps middle-class families cope at Building a Brighter Future.

Short Sales are the New Foreclosure

A new federal program could help those who are destined to lose their homes to at least avoid foreclosure -- and the repercussions of that drastic step.

By Sally Herigstad-- MSN Money

Steve and Debbie Martin are losing their home. That's for sure.

Foreclosure alternatives

The only question is whether it will be in a short sale or a foreclosure. They've found a buyer, who is offering less than what they owe. The Martins just have to get the bank to accept the offer.

In the past, that's been a tall order. Since the housing meltdown began, short-sale offers have often taken months to get a response from overwhelmed lenders. Even then, there have been no clear guidelines about what kinds of offers are acceptable or about how to handle second mortgages that could easily derail the process.

Industry experts estimate that less than half of short-sale offers have been accepted, and many real-estate agents have avoided showing these properties altogether. Ultimately, most of the homes go into foreclosure .

The short sale option

But if the Martins can hold on until April, a new federal program might help.

Starting April 5, lenders in the Home Affordable Modification Program must offer borrowers the option of a short sale, including the minimum amount needed for an acceptable offer, if their mortgage doesn't qualify for a modification.

Once a homeowner applies to list his home as a short sale, lenders must respond to offers within 10 days. The program also offers $1,500 to homeowners to help them move, $1,000 to loan servicers to cover the cost of paperwork and up to $3,000 in incentives to secondary lenders who might otherwise reject an offer.

How you lose your home matters

The Martins bought their home in 2003, when they needed a larger house for themselves, their three grown children and one grandchild. Steve and Debbie made the down payment, and all five adults signed on the loan. Everyone chipped in on the mortgage payments.

The Martins figured that when their kids moved away, they would sell the house and all would share the profits. Then property values in the Pacific Northwest plummeted. As the nest emptied, Steve and Debbie started having trouble paying the mortgage.

Now the Martins can no longer sell the house even for the amount they owe on it. But they don't want to just walk away. They feel a moral obligation to try to pay back their loan, and they don't want to trash their and their children's credit scores. The Martins tried everything before asking the bank to accept a short sale. Steve started taking one of his pensions early in an effort to make ends meet, but it wasn't enough. "We tried to refinance," he said. "We tried that with three institutions, and they all said no because there were too many people on the mortgage. We tried loan modification and had the same issue."

Millions of people like the Martins are finding it hard to hang on to their homes as the Great Recession squeezes both household income and housing values. And many others who owe a lot more than their houses are worth may just want out. Walking away, however, is a terrible choice -- one you could regret for years.

Here's why:

You could get hit with a deficiency judgment. It's common to assume that if you walk away from your home, the bank can't come after you for more money, because the loan was attached to the house.

But that's not always true. In some states, lenders can obtain a deficiency judgment for the difference between what you owed and what they got from selling your house.

Florida is one of those states. "No homeowner should walk away," says Rashmi Airan-Pace, a Florida attorney who specializes in mortgage modifications and foreclosure defense. "Deficiency judgments are very damaging."

Airan-Pace points out that lenders, for example, can seek to garnish wages or place liens on other properties.

Other states, including California and Arizona, are nonrecourse states, which means that laws there prohibit such judgments. You still have to be careful, though; some lenders get borrowers to sign papers obligating them to pay deficiencies anyway.

Foreclosure can ruin your credit scores for up to 10 years. When it comes to the effect on your credit scores, having a few late bills is to foreclosure what having a leaky faucet is to burning down the house.

"When a foreclosure is filed against a property owner, that person's credit will go down 100 points," Airan-Pace says. "At the foreclosure sale, it goes down another 100." She estimates that a short sale would do about one-quarter as much damage to your scores. And though you can start pulling up your credit scores substantially from a short sale or a spate of late payments within a couple of years, a foreclosure can affect your credit history for a decade.

First, do all you can to keep the house

Before you think about letting your home go, make sure you've exhausted every other possibility.

If you can save your home by working extra hours, staying on a strict budget or taking money out of savings, you should consider it. (In general, don't touch your retirement accounts, however.) If you just want out because the value is down, remember that a house is still a place to live, regardless of what the market says it's worth. You would also be wise to consult a credit counseling organization, such as the National Foundation for Credit Counseling, or hire an attorney.

According to the nonpartisan Urban Institute, borrowers facing foreclosure are 60% more likely to hold on to their homes if they receive counseling. When you hit trouble, the first step is to see whether you qualify for federal programs that help you refinance your home at a lower rate or reduce your mortgage balance. Be patient. And be prepared for lots of paperwork. The Martins say they have faxed more than 80 pages at a time to their lender.

Sam Hussain of ClearPoint Credit Counseling Solutions in Modesto, Calif., says that people often get frustrated when they have to fax the same paperwork more than once. "That's reality," he says. "Ask for the mailing address, and use certified mail." Hussain also recommends you use a notebook to make a conversation log through the process. Write down the name of every person you talk to, the date you spoke and what was said.

It should go without saying that getting your legal advice from scam outfits that advertise in spam e-mails or on utility poles is a bad strategy. As Lee Jones, a spokesman for the Department of Housing and Urban Development in the Northwest, says: "They fold up in the night like a lawn chair and take your money with them."

It's also good practice to steer clear of well-intentioned people who are out of their field. Taking advice from friends, relatives and even your real-estate agent can be a costly mistake.

A credit counselor or attorney can be helpful if saving your home proves impossible and you seek to complete a short sale or deed in lieu of foreclosure. Keep in mind that banks will want to know that you tried every other avenue first.

How to get help losing your home the right way

A new federal program, Home Affordable Foreclosure Alternatives, encourages banks to accept short sales by offering them financial incentives to do so. It offers sellers incentives, too.

Homeowners win because:

• They won't get stuck with a deficiency judgment. Under the program, homeowners are released from all obligations.

• They can receive $3,000 in relocation expenses.

• They can't be charged any fees to participate.

Creditors win, too, because they don't inherit a vacant home to maintain. As big as the losses in short sales can be, the losses from foreclosure can be even bigger -- by some estimates, as much as 60% of what's owed on the mortgage.

Secondary lenders, who often stand to get nothing in foreclosures, can receive up to $6,000.

You may qualify for the foreclosure-alternatives program if:

• You have tried unsuccessfully to get a mortgage modification through the Home Affordable Modification Program .

• The property is your principal residence.

• You got your first mortgage loan before Jan.1, 2009, and it is guaranteed by Fannie Mae or Freddie Mac.

• You are behind on your mortgage or will be in the foreseeable future.

• You owe no more than $729,750.

• Your total monthly mortgage payment is more than 31% of your income before taxes.

The foreclosure-alternatives program is set to expire Dec. 31, 2012. Some critics predict that it will be as disappointing as the loan-modification program, which was launched in March 2009. Out of millions of distressed homeowners, just 170,000 had received permanent modifications as of the end of February, according to the Department of the Treasury and HUD. (Many more modifications are being offered or are in the trial phases.) The median decline in monthly mortgage payment was about $500.

Will the new program be any better?

"It's half right," says Mary Tootikian, the author of "Stunned in America: Sub-Crime Mortgage Crisis." "The intent of it is good." She worries, however, that the new program's application process will allow lenders to find out borrowers' incomes and assets. "After they go through this fact-finding mission and they find out you have assets to go after, they don't have to let you do a short sale," she says.

Arian-Pace, the Florida attorney, is more optimistic. "The frustration of short sales is the timing of it all, getting banks to approve it," she says. "You often lose the buyer in the process. I'm hoping it's a step in the right direction. Really, it's going to come down to how the banks implement it."

Supreme Court: Order Requiring Mediation

Florida created a Task Force on Residential Mortgage Foreclosure Cases in March of 2009. The task force issued a Final Report on August 15, 2009 recommending all residential foreclosure cases be referred to mediation.

On December 28, 2009, the Supreme Court of Florida approved this recommendation and an Administrative Order was signed. The Order is to be executed in each judicial circuit. The Order, and model mediation forms for use in this new statewide program, can be found by clicking HERE. The Order provides that only Florida Supreme Court-certified mediators trained in residential foreclosures may be assigned to mediate these issues. Given the immense time and cost of this new program, outside help has been sought to coordinate the program in the various judicial circuits.

Florida is a Judicial foreclosure state.