With the election over, the ‘fiscal cliff’ and its children are coming back into the news cycle. Yesterday, forty-one state Attorneys General signed a letter urging the extension of the Mortgage Debt Relief Act of 2007, set to expire at the end of this year. Their stated reason? Their statement that the national mortgage settlement they struck in April of this year will be blunted by its expiration.

Does it really matter if the Act expires or not? No.

People are lining up predicting both its extension and its demise. On the demise side, heavily cited is the $1.3 Billion/year in uncollected revenues, as projected by the Congressional Budget Office. On the extension side, people point to the $1.3 Billion/year tax ‘increase’ of not extending it and claim that it will destroy the short sale market and borrower participation.

Unfortunately, this is a situation of some pundits having just enough information to be dangerous. The reality is it doesn’t really matter if the law expires, as far as the macro market goes. If you have a financial hardship, you will likely not pay taxes anyway. The Mortgage Debt Forgiveness Relief Act altered the IRS tax code adding an additional exception for owner occupied properties where the forgiven debt was used for the purchase or substantial improvement of that property, up to a limit of $1M if you are single and $2M if married. The key word there is additional.

When Congress passed the Mortgage Debt Forgiveness Relief Act, the IRS code already provided forgiven debt tax forgiveness for insolvency, with no upper limit or other resctriction. If you had debt of any kind forgiven and you were insolvent at the time it was forgiven, then you did not have to pay taxes as long as you filled out the IRS tax form. And just for clarity, insolvency is a simple concept for the IRS code: if you owe more than you have, you are insolvent. So if you have $20,000 in savings and stocks along side a $300,000 mortgage on a house worth $225,000, then your net worth is at most $300k-$245k = -$55k. That means you are insolvent. Most people who are doing a short sale are insolvent. That’s why they are doing the short sale.

One other item to note. For those who think people will refuse to short sell because of the expiration of the Act, the correct question back to them is this: what’s their other option? Foreclosure? If they are foreclosed on or do a deed-in-lieu of foreclosure, the same tax issue exists because the bank is forgiving recourse debt. Unless the bank chooses to get a judgment and pursue that judgment, then they are going to forgive the debt so they can take the write off. They take the write off, they issue a 1099C to the former borrower, and that borrower now has income to pay taxes on. People who are considering a short sale are not deciding whether to keep the house or do a short sale as a rule. It’s not a stay or go situation. They are moving out. The only question is, how and on what terms?

So you might ask, what’s the deal with the noise about the expiration of the Mortgage Forgiveness Debt Relief Act? Well, politicians do not like to be seen doing nothing. So, it’s partially political theater. Also, the people who will have $1 – 2M in debt forgiven also are likely to have a fair amount of access to their political representatives, and politicians don’t like to be seen not taking action, especially to people who have access to them. Beyond that, the noise seems mostly to do with a lack of understanding of the IRS tax code, surprise surprise.

So, what does that mean at the end of the day for short sales and taxes? Well, short sales will continue to take place whether or not the Act is extended, because the vast majority of people doing them don’t have a choice to keep the property. Most people who sell via short sale will have no tax implications provided they complete the proper form to file with their taxes.

Don’t buy the hype. There may be a fiscal cliff, but for the vast majority of sellers, there is no tax cliff January 1 for short sales.

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On DSNews. On the Orange County Register http://t.co/upCFmygU posted by @NextGenRECorp last month

Notice: This article is not intended as legal or tax advice for you or your specific situation. If you need tax or legal advice, you should consult your accountant or attorney.