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Short Sale Issues: Expiring Debt Relief Act & Deficiency Judgments

The Mortgage Fairness Debt Relief Act passed in 2007 will expire on December 31st, 2012. This Act was passed to assist homeowners struggling with underwater homes, eliminating taxes on the debt forgiven in the short sale.

It is important for local homeowners to understand these tax issues, because it may have significant consequences on their long-term finances as they seek to get out from an underwater home and start fresh again. Many professionals working in the field note that many people are not made aware that they might have to pay tax on a forgiven debt from a property they had to sell or walk away from.

The potential expiration of the Act has different consequence depending on whether one lives in a “recourse,” “non-recourse,” or hybrid state. There are twelve “non-recourse” states, where, following a foreclosure or a short sale, the homeowner generally has no personal liability for the debt owed on the home, provided the money loaned was used to purchase the home.  Unfortunately, New Jersey is not one of those states.

What It Means If You Are in a Recourse State

“Recourse” basically means that state law allows the lender to come after you (has recourse against you) if your house is sold at auction or through a short sale for less than the amount owed the lender. For example, if you borrowed $350,000 to buy your home and it sold for $200,000 there is a deficiency of $150,000.

In our area it is crucial to get tailored advice on New Jersey law regarding these issues by contacting one of our Burlington County short sale lawyers. The Impact of Federal Tax Law Section 108 of the Internal Revenue Code, the little known tax law the federal debt relief expanded on, says that forgiven debt will be taxed. Section 108  applies to any debt attached to a property that is two and a half acres or less, where the money was used to buy the property and the property is capable of residential occupancy. But even without the debt relief act there are three exceptions to this rule.

(1) In non-recourse states, any remaining debt after the property is sold is not considered debt so the tax doesn’t apply to it.

(2) The second exception allows a homeowner to escape the tax debt if he or she is insolvent on a balance-sheet basis at the time of the short sale.

(3) The third exception covers anyone who is bankrupt or going through a bankruptcy.

The Mortgage Debt Relief Act essentially holds that the tax will not apply in most cases no matter what type of state one lives. It also covers obligations secured by the property that were not used to purchase it. (i.e. you took out a home equity loan and bought other things with the money, like cars or stocks).

These tax and deficiency issues can be quite confusing.  It is crucial to receive professional New Jersey short sale help to get information on the issues that will apply in your case.