New Foreclosure Related Legislation

DISCLAIMER: THIS IS NOT INTENDED TO BE TAX ADVICE. FOR TAX ADVICE FOR YOUR SPECIFIC SITUATION, CONSULT WITH A TAX PROFESSIONAL. 

Though my work is lender focused, I frequently receive calls and emails from borrowers who want to know if they can just "walk away" from their loans.

From my previous posts, it is obvious that I work for lenders pursuing judicial foreclosures and deficiency judgments.  (See previous blog entries regarding California's One Action Rule and Anti-Deficiency statutes).  That means that while I can quote verbatim from the statute about which loans are recourse, that does not mean that I know anything about the specific tax consequences. 

In addition to the possibility of a deficiency judgment, the borrowers who cannot meet their loan committments could have tax consequences. 

Generally in short sale situations, the debt remaining is treated as a debt forgiveness--which creates income.  The most interesting piece of new legislation I've seen is the Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) which snuck in quietly in late 2007.

If the borrower meets certain criteria, the debt cancelled will not be treated as income for federal income tax purposes.  This act applies to income in 2007, 2008 and 2009.  The catch?

That doesn't solve the state tax consequence.  Since California has not passed a companion law yet, the California Franchise Tax Board likely takes a different view of the situation. 

That might change for next year, but in the meantime--borrowers who are paying to sign up for these "homeowner walk away" from their mortgage should beware.  There is no one size fits all solution.  No one can predict how a lender will choose to deal with a bad loan, or the likelihood the lender will pursue a judicial foreclosure and seek a deficiency judgment.