Fiscal Cliff for Short Sales Too!

If Congress drives the economy off the "fiscal cliff," wave goodbye to short sales that have helped the housing market get back on its feet.

At risk is a provision that erases taxes on selling a home for less than what's owed to the bank. Expiration of the tax treatment would create a major new headache for the one in four homeowners who owe more than their house is worth. Those "underwater" sellers would have to come up with a big check for Uncle Sam to pay the tax on the difference.

That “would be a blow to the housing recovery,” said Paul Diggle, a housing economist at Capital Economics. “The increased use of short sales, rather than foreclosures, has become an important support to the recovery.”

Currently, roughly a quarter of all home sales are short sales. Bank of America Wednesday reported that some 62,000 borrowers have completed short sales that saved them $7.4 billion in debt, or an average of about $120,000 each. In 2007, as the housing boom turned to bust, Congress passed the Mortgage Debt Relief Act, which shielded such forgiven debt from taxes.

The law was extended in 2010 but is due to expire at the end of the year unless Congress acts to steer away from the so-called “fiscal cliff.” Separate bills have been introduced in the House and Senate to extend the mortgage relief tax break for another year. The measure would cost about $1.3 billion in uncollected taxes. The law is credited with helping pull the housing industry out of the worst recession in nearly a century. Though still deeply depressed, sales of both new and existing homes have been steadily rising.

 Home prices appear to have bottomed out and are rising again in many parts of the country. Restoring the tax on debt forgiveness could throw cold water on one in four home sales by sticking the seller with a large tax bill. “If (homeowners) decide that a short sale is not the best option, and they just allow (the mortgage) to be fore closed, that has a more negative impact on the neighborhood and on home values,” said Blomquist.

That would be bad news for lenders, too. The average price of a bank-owned property seized in foreclosure is about $30,000 lower than comparable house transferred in a short sale. Banks also avoid the legal costs of seizing a home and the extended cost of maintaining it. “(A short sale) really does work out to both the borrower’s and lender’s benefit in most cases,” said Michael Fratantoni, a research analyst at the Mortgage Bankers Association.

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