Mortgage and Foreclosure Law Blog

Buenos Dias Web Surfers! Today I'd like to tell you about some good news from the IRS. I know it sounds like an oxy-moron; but once in a while we taxpayers are "given a break". This is what happened with The Mortgage Forgiveness Debt Relief Act of 2007.

First of all let's talk about something ridiculous the IRS does; Cancellation of Indebtedness Income (COD). What is COD Income? Let's say you owe me $10,000 and I tell you, "you know what, just give me $1,000 and we'll call it even." So I just let you off the hook for $9,000. Guess what? The IRS is going to tell you that you just had $9,000 of income and you need to pay taxes on that $9,000. Sure they have good reasons for this; but I hate it. The problem we were facing as we did mortgage modifications was that people were getting 1099s from their lenders for COD income they "received" when they started paying less for their mortgages or when their delinquencies were forgiven.

Well obviously this was a huge problem. Here we had thousands and thousands of people who were struggling financially and couldn't pay their mortgage, and just when they get help, the IRS was going to swoop in and tax them on money that was never in their hands. Enter The Mortgage Forgiveness Debt Relief Act of 2007.

This act "forgives" taxpaye'rs COD Income where debt is reduced either through a mortgage modification/restructuring or debt forgiven through a foreclosure. The amount allowed is $1 Million for a single filer and $2 Million for Married Couples Filing together. Yea! There is one downside though. The amount forgiven reduces the taxpayer's cost basis in the property.

Quickly I'll explain cost basis. If you buy a house for $100,000, your cost basis is $100,000. If you sell the house for $200,000 the IRS uses your cost basis to determine how much you gained. In this case, you would have gained $100,000 and the IRS would tax you on that $100,000. If you had $50,000 of COD income your cost basis in the example here would be reduced to $50,000. Now if you sold the house for $200,000 you would be taxed on a gain of $150,000. See the IRS always gets you in the end; but at least this way you actually have money in hand to be taxed on. That's it for today!

Over the past few months our TV news programs have been filled with Members of Congress or an Administration official placing blame on the Mortgage Meltdown in the hands of a financial company official whose poor decisions and greed resulted in huge financial losses and great suffering. Ironically, it is many of these Washington Officials who advocated the mortgage lending policies that led to the economic turmoil.

In the early 1990s, Fannie and Freddie came under substantial political pressure to lower lending and underwriting standards in order to help more people achieve the dream of becoming homeowners. In particular these behemoth lenders were coerced into lowering the size of down payments and the credit quality of borrowers. Lower down payments led to housing prices that outpaced income growth.

Once Freddie Mac and Fannie Mae lowered their lending standards, the open market had to follow pace in order to compete. When this happened, home prices became increasingly untethered from any kind of demand limited by borrowers’ ability to pay. Instead, borrowers could just make smaller down payments and take on higher debt, allowing home prices to continue their unrestrained rise. Some statistics help illustrate how this occurred. Between 2001 and 2006, median home prices increased by an inflation-adjusted 50 percent, yet at the same time Americans’ income failed to keep up.

Fannie Mae and Freddie Mac were leaders in risky mortgage lending. Fannie and Freddie purchased $1.9 trillion of mortgages made to borrowers with credit scores below 660, one of the definitions of “subprime” used by federal banking regulators. This represents over 54% of all such mortgages purchased between 2002 and 2007.