Investors still on tax hook

August 21, 2008
Author: Shannon Behnken, Tampa Tribune, Fla

TAMPA, Fla. – Aug. 21, 2008 – For homeowners in trouble, a short sale can be a lifesaver.

Lenders allow a house to be sold for less than is owed on the mortgage and then write off the rest. The homeowner just walks away.

Unless the owner is an investor, that is.

A short sale gets these owners off the hook for the loan, but many will get a surprise from Uncle Sam next tax season: an income tax bill based on the amount forgiven by the lender.

“I’m telling you this is going to be a big issue,” said Ralph Fisher, a Lutz attorney who specializes in foreclosure. “If you’re an investor, watch out.”

As the Bay area’s foreclosure rate steadily increases each month, short sales are becoming a popular alternative for financially strapped homeowners who owe more than their homes are worth.

Late last year, as lenders started to permit more short sales, President Bush signed the Mortgage Forgiveness Debt Relief Act. Before the legislation, all homeowners had to pay income tax on the loan amount written off by the lender. Under the new law, owners won’t have to pay taxes on that amount, up to the original mortgage amount on the purchase of the home. But that’s only if the home is their primary residence.

The president and legislators apparently took no pity on investors who gobbled up properties by the dozens during Florida’s red-hot housing boom and now can’t pay their mortgages. Those buyers, if they’re lucky enough to get a lender to agree to a short sale, will be stuck paying the resulting income tax.

That goes for owners of secondary homes as well, said Sue Hales, spokeswoman for the IRS. Homeowners who work out a short sale should receive a 1099 tax form with their lenders, she said.

Once they get the form, she said, they should carefully check the values of the shortfall amount and the house value.

For example, if a homeowner owes $250,000 on a mortgage and the lender agrees to let him or her sell the home for $200,000, the lender would forgive the $50,000. But if the owner doesn’t live in the home, he or she will have to claim the forgiven $50,000 as income.

Until late last year, the average homeowner had never heard of a short sale. Now, neighborhoods throughout the Bay area are dotted with for sale signs denoting the home as a “short sale.”

Of the 16,677 Hillsborough County area homes listed for sale in the Multiple Listing Service, nearly 20 percent are marked as a short sale. Brad Monroe, a real estate agent and former president of the Greater Tampa Association of Realtors, said he thinks the actual number of short sales occurring is much higher. Agents in Pasco County report short sales are as high as 60 percent of the properties they’re selling.

With real estate generally slow all over Florida, some real estate agents and title companies are specializing in getting lenders to approve short sales. Borrowers facing foreclosure are jumping on the opportunity.

Getting a short sale approved at all is difficult, and lenders aren’t always willing to approve them. However, faced with millions of dollars in losses in foreclosures – plus court costs – they are more likely now to approve short sales. Still, real estate agents say the approvals are often delayed or denied.

When homeowners do get approved for a short sale, a lot of borrowers aren’t getting good tax advice from some of the real estate professionals helping them with their deals, said Mike Edenfield, an attorney who works with foreclosures.

“Most people aren’t aware of it at all,” he said of the income tax requirement. “Florida is typically a debtor’s paradise. But the IRS has a super priority. For the investor out there who bought a bunch of condos and is now in trouble, they’re going to get bitten.”

Ron Donalson, a principal with Alday-Donalson Title Agencies of America, travels the state holding how-to workshops for real estate agents. He said it’s up to the real estate agent to inform sellers of this rule. Often, though, investors call him looking for an easy way out.

“You wouldn’t believe all the investors who come in wanting to sell their three houses as short sales,” he said. “They took a gamble, and they’ll have to pay income tax just as they normally would.”