What is the MFDRA?
Today's question is, what is the Mortgage Forgiveness Debt Relief Act and how will it apply to me?
We'll be discussing the key features of the Mortgage Forgiveness Debt Relief Act and whether or not it will be around by the time you close on your short sale transaction.
Starting with a little bit of historical perspective.
We want to go back to 2007 when the Mortgage Forgiveness Debt Relief Act was first enacted by Congress. Now, this was a critically important piece of legislation that shielded homeowners from any tax liability arising from forgiven debt following a short sale, deed in lieu or foreclosure.
Now, since 2007, the Mortgage Forgiveness Debt Relief Act, we'll just call it the Act for short, has expired three times, and since then, it's been renewed three times. Most recently, the Act expired at the end of 2014. Now, while I maybe cautiously optimistic and somewhat hopeful that Congress will come to their senses and do the right thing by extending the Act through 2015 and beyond, I can't rely on a mere hunch or speculation to advise my clients. So we maybe living in a post-Act world where we have to look to alternative methods, alternative means by which to shield homeowners from tax liability following a short sale.
The two key elements that must be satisfied in order for the borrower to claim that exemption and shield themselves from any tax liability under the Act are as follow.
Number one, qualified principal residence. It must be your home, meaning that you lived there for two out of the last five years. That's the definition of a qualified principal residence under the terms of the Act. It doesn't matter which two. It doesn't have to be the most recent two years. It doesn't even have to be consecutive two years. So long as you've lived in that home for two out of the last five calendar years, you've satisfied one element of the Mortgage Forgiveness Debt Relief Act.
The other element that must be satisfied in order for you to claim that exemption is the mortgage debt itself must have originally been used as purchase money. So the debt that the bank is forgiving, the loan amount that is being forgiven must have originally been used to either purchase the house, what we call purchase money, or when we're talking about a second, a junior lien, a subordinate lien or a home equity line of credit, those proceeds must have been used to substantially improve or repair the house. Now contrast that with a situation where the borrower takes out a home equity line of credit, and instead of putting that money back into the home, they decide to go buy a new car.
In the event that the lender forgives that debt on the HELOC.
Forgives that home equity line of credit, the borrower may have some tax liability arising from the forgiven debt because it wasn't purchase money and the money wasn't used to substantially repair or improve the house.
So now that we know how the Act works, we can all be cautiously optimistic about Congress renewing the Act and we'll know what to look for as far as satisfying those elements to determine whether or not you, as the borrower, are eligible to claim that exemption following a short sale.