Keeping the Home: Special Issues for Mortgage Modifications, Refinancing and Reverse Mortgages

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1 2013 National Aging and Law Institute: November 7-9 Washington, DC Keeping the Home: Special Issues for Mortgage Modifications, Refinancing and Reverse Mortgages Presented by: November 9, 2013

2 What We ll Cover Overview of options Tax consequences, including new IRS guidance for HAMP modifications Special issues for widows, orphans, and heirs

3 Home Saving Options HAMP modification HARP refinancing Reverse mortgage refinancing Other options: Proprietary modification Regular refinancing???

4 HAMP Modification Equity in home will usually prevent a HAMP mod Function of NPV test The 31% affordability standard may limit HAMP availability for seniors High medical bills, second liens may mean that 31% is not affordable Sometimes HAMP Tier 2 may be an option, but run the numbers Always use CheckMyNPV.com to determine eligibility

5 HARP Refinancing Only GSE loans Have to be current, with good payment history for 12 months LTV has to be greater than 80% equity Borrowers with substantial equity who have fallen behind won t qualify for either HARP or HAMP Homeowners in default won t qualify for HARP Getting the refinance done may not be easy

6 Reverse Mortgage Refinancing Expensive Has to be substantial equity in the house Going forward, financial assessments will be done.

7 Home Losing Options Sale Short sale Deed in lieu Foreclosure

8 Sale Best option if there is equity in the home may allow homeowner to retain equity

9 Short Sale If there is no equity, worth pursuing. Impacts credit score. Getting them done and approved is always tricky Think about: Cash for keys Waiver of deficiency

10 Deed in Lieu/ Foreclosure Both will have equivalent impact on credit score Deed in lieu should offer cash for keys and waiver of deficiency Deed in lieu worth considering as option for judgment proof clients who cannot retain home for whatever reason, particularly where negative equity in the home Foreclosure may give the homeowner more time

11 Tax Issues Happen in foreclosure, short sale, loan mod, etc. Two basic kinds: Capital Gains When the house is sold or foreclosed on and the value of the house is more than $250,000 over its acquisition value Form 1099 A Form 1099 C Discharge of Indebtedness Whenever any debt is forgiven If additional cash paid or if the lender pays the consumer s attorney any fees may also create taxable income

12 Wait, I Lost My House. How Can I Have Capital Gains? Debt forgiven in exchange for the house is treated as a return on capital Capital gains are the difference between the sales price and the basis in the house Basis is purchase price plus improvements The sales price is the lower of: the debt forgiven plus any cash the fair market value of the home Can have both discharge of indebtedness & capital gains in a foreclosure

13 Exclusion From Capital Gains If home was primary residence for 2 of last 5 years, $250,000 per individual $500,000 per married couple

14 Capital Gains Example Tom & Jane bought their house for $50,000 in At the time of the foreclosure, the mortgage debt is $325,000. Tom & Jane also get $5,000 in cash for keys. Value of their house $300,000 at time of foreclosure.

15 What Are Tom & Jane s Capital Gains? Capital gains are the lesser of the two: $340,000 Debt Forgiven + Cash $305,000 FMV + Cash $50,000 Basis $50,000 Basis $280,000 Capital Gains $255,000 Capital Gains

16 What Is Taxable? If Tom and Jane are still alive, and together in the home, the combined exclusion is $500,000 $500,000 > either $280,000 or $255,000, no capital gains If Jane is in the house by herself, she can only exclude $250,000 of capital gains $255,000 $250,000= $5,000 of capital gains

17 CAPITAL LOSSES ARE IRRELEVANT E.g., Nancy bought her home in 1999 for $125,000 and has mortgage debt at the time of foreclosure of $132,000. Her home is worth $100,000. Nancy has a capital loss of $25,000 (fair market value is less than the mortgage debt). Nancy has no capital gains tax implications from this Tax code does not permit recognition of a capital loss on a residence. But she does have potential taxable income from discharge of indebtedness if the lender waives the deficiency

18 Discharge of Indebtedness (DOI) Cancellation of Debt Whenever debt is forgiven, normally treated as income. Why? Money received when loan taken out But not taxed because of obligation to repay Interest & fees need not be treated as discharge of indebtedness, only principal

19 Examples of DOI Foreclosure sale, if for less than amount of debt & lender does not seek deficiency judgment E.g., Nancy probably has $32,000 of DOI income Short sale Loan modification with reduction of principal Theoretically, loan modification with significant interest reduction or principal forbearance

20 Why Does DOI Matter? Lenders usually file 1099 C s. If borrower does not report the DOI income on her tax return, the IRS s automated audit system will pick it up. Borrowers can get dunned by IRS for interest and penalties on underreported tax

21 What to Do?? Determine how much will be reported. Provide your client with information about why the debt was discharged and how much. Refer your client to a tax lawyer or CPA These issues are out of scope for the free tax assistance sites (VITA and Tax Counseling for the Elderly), with a few limited exceptions Tax clinics associated with law schools may be more helpful

22 Dealing with DOI and the IRS Homeowners must: File long form 1040 Attach Form 982 Homeowners will usually need to attach to Form 982 an explanation of why the DOI is not income If a homeowner gets a dunning notice from the IRS, they can contest it If a homeowner hasn t reported it, they can amend their return

23 Common Exclusions from DOI Can t pay Bankruptcy Insolvency Indebtedness related to acquisition of qualified principal residence Illegal debt Disputed indebtedness Fraud in purchase

24 Bankruptcy 26 U.S.C. 108(a)(1)(A) If debt discharged in bankruptcy, the discharged debt excluded from taxable income Debt discharged in bankruptcy need not be reported Timing is everything: debt must be discharged during the pendency of the bankruptcy, not before and not after

25 Insolvency 26 U.S.C. 108(a)(1)(B) Measured as assets less liabilities immediately before the discharge Can be partial Not clear if you subtract exemptions IRS says no Contrary to long standing rule

26 Insolvency Example Assets, including the house, worth $120,000 Liabilities, including mortgage, of $140,000 Taxpayer is insolvent in the amount of $20,00 before the discharged mortgage debt If the mortgage principal reduced by $15,000, no DOI income If the mortgage principal reduced by $25,000, $5,000 of DOI income

27 Acquisition/ Qualified Principal Residence Indebtedness (QPRI) Applies to debt forgiven in 2007 through 2013 Debt must be forgiven because of the homeowner s financial condition or a decline in value of the collateral Qualified principal residence indebtedness Principal amount of acquisition debt, even if refinanced Improvements that increase the basis. Practically, only purchase money mortgages

28 When You Have Acquisition & Home Equity Debt If debt is mixed QPRI and home equity You have to discharge all home equity debt before you can count a discharge as QPRI Home equity debt can be excluded using the insolvency exception and then any remaining acquisition debt forgiven may be excluded as QPRI 26 U.S.C. 108(a)(1)(E)

29 QPRI Example Home purchased for $100,000 $10,000 of principal paid $90,000 of acquisition price refinanced, refinancing rolls in some other, non mortgage, loans New loan $130,000 $90,000 acquisition indebtedness $40,000 home equity debt

30 QPRI Example Scenario 1: $35,000 of mortgage debt forgiven QPRI not available Insolvency exception could be used Scenario 2: $45,000 of mortgage debt forgiven QPRI available for $5,000 of the debt Insolvency exception could be used for $40,000

31 Disputed Indebtedness If the debt was never a valid debt, then its discharge does not result in income This will arise mostly in the context of the settlement of litigation Distinct from debts that become unenforceable due to passage of time

32 Purchase Price Infirmity Only applies to purchase money mortgages. General doctrine: if seller reduces price, that is not income. If a lender reduces a purchase money mortgage not income if Reduction due to fraudulently inflated purchase price Borrower has clean hands. Rev. Rul

33 THE SPECIAL CASE OF HAMP PRINCIPAL REDUCTION MODIFICATIONS Annual borrower incentive payments under HAMP (pay forperformance) don t count as income IRS Rev. Rul Payments to the investors to encourage principal reductions, subsidize loan modifications, don t count as income. IRS Rev. Proc , at 14 Payments made to or on behalf of borrowers under the Hardest Hit programs don t count as income. IRS Notice , I.R.B. 544

34 Timing of Income recognition under HAMP HAMP mods spread out the reduction over 3 years Can either recognize the income over three years or all at once, when the permanent modification goes into effect Most homeowners will minimize their tax consequences if they recognize the full amount of forgiven debt as income at the time the permanent modification is executed. Maximizes use of insolvency and QPRI Simplifies accounting and record keeping Homeowners can amend prior returns Rev. Proc

35 Discharged Interest Previously deducted interest: Prior tax benefit must be offset with tax liability when interest forgiven/ repaid Reduction of future interest rate If below applicable federal rate, difference in yield may be taxable Applicable federal rate published monthly in IRS Bulletin 26 C.F.R et seq. Often, lenders do not report the reduced future interest rate on a 1099 but this is why it is important to be clear on the dollar amount that will be reported

36 Special issue: home transfers After Death or Divorce Family member inherits house, or gets it in divorce Not named on note May need a modification Servicer won t talk to them

37 WHAT We ll talk about Assumptions Should the client assume the mortgage? Can the client assume the mortgage? Special rules HAMP Freddie & Fannie FHA Practice tips for divorce and death Litigation theories

38 What s An Assumption? Often client is on the mortgage, but not the note, and wants to keep the house. Assumption subjects client to personal liability on the note Gives clients all rights of mortgagor Does not relieve original mortgagor of personal liability unless creditor agrees

39 Starting point:what Does The Client Want? Question: To assume or not assume? Assuming makes client personally liable on note Not assuming the mortgage usually means losing the home (because the mortgage can t be modified, generally, unless the client is personally liable on the note) This is a financial, legal, and emotional assessment that has to happen FIRST. Client s decision, not the servicer s or mortgagee s The assent of the obligor is not ordinarily necessary to make an assignment valid. Restatement 2 nd of Contracts 323 Comment a

40 What To Do? TO ASSUME OR NOT ASSUME Always start with what your client wants long term Can they keep the house? Do they want to be personally liable on the note? Is client judgment proof? Can they pay note even with a modification? Is their ownership interest subject to the mortgage? After acquired Waiver of homestead Signed the mortgage If ownership interest is not subject to mortgage, what happens?

41 When Would You Advise the Client not to Assume? PRACTICALLY If client can t pay the note, even after modification (particularly if the client isn t judgment proof) If the client can t pay the note, and you don t think they can get a modification If the client doesn t want to keep the home

42 WHEN WOULD YOU Advise the Client Not to Assume? LEGALLY If the property is held in tenancy by the entireties, and your client didn t sign the mortgage Mortgages generally aren t effective unless signed by both tenants in a TBE Maybe if it s in TBE, and the client signed the mortgage, but not the note Maybe if the property was held in joint tenancy, the other joint tenant is dead, and your client didn t sign the mortgage Maybe if your client had a homestead interest and there was no waiver of homestead

43 How Do You Get An Assumption? No necessary formal words Restatement 3 rd of Property, Mortgages, 5.1 Caselaw is mostly about protecting new owner from presumption of assumption Making payments, seeking modification can show assumption Chicago Assets Co. v. Watrous, 262 Ill.App. 254 (1 st Dist. 1931)

44 Assumptions Help Mortgagees Absent a release, the mortgagee can still sue the original mortgagor; assumption adds another party to go after on the debt Restatement 3 rd of Property: Mortgages 5.1 Bay v. Williams, 1 N.E. 340 (Ill. 1884) (granting mortgagee right to sue to collect mortgage debt from grantor even though mortgagee was not a party to the assumption)

45 Due On Sale Clauses Permit the mortgagee to call the mortgage due and payable if the property is transferred Don t usually forbid assumptions, per se, but assumptions of residential mortgages seldom happen outside a transfer of ownership See Restatement 3 rd of Property, 5.1, 5.2 No due on sale clause, no right to foreclose when property transferred Coffing v. Taylor, 16 Ill. 457 (1855)

46 ExaMPLE OF Due on Sale Clause If all or any part of the Property or any interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender s prior written consent, Lender may require immediate payment in full of all sums secured by the Security Instrument. Note: In theory, this should make clear that it is subject to applicable law, but not all do

47 Courts Strike Down Due on sale Clauses In 1970s, homebuyers took over the seller s existing mortgage rather than taking out a new mortgage at double digit interest rates Banks tried to enforce due on sale clauses against these home buyers / loan assumers Courts across the country often held that due on sale clauses were unenforceable as a matter of state property law, including state law banning due on sale clauses. E.g., Wellenkamp v. Bank of Am., 582 P.2d 970, (Cal. 1978) Key: unreasonable restraint upon alienation of property

48 Garn St Germain Depository Institutions Act Garn St. Germain Depository Institutions Act at 12 U.S.C. 1701j 3 et seq (1982) Pre empts state laws that formerly protected homeowners against bank s oppressive use of due on sale clauses: Notwithstanding any provision of the constitution or laws (including the judicial decisions) of any State to the contrary, a lender may enter into or enforce a contract containing a due on sale clause with respect to a real property loan.

49 Silver Lining: exceptions to Garn A due on sale clause cannot be enforced when an interest in real property is transferred: To a relative resulting from the borrower s death To a spouse or child To a spouse pursuant to a divorce decree or separation agreement And others. See 12 USC 1701j 3(d)

50 What Garn Should mean You can t use a due on sale clause to refuse to honor an assumption that is in one of the protected classes Fannie Mae Servicing Guide 408 recognizes this legal reality, calling for non qualified assumptions for widows, heirs, divorcees BUT Garn has no private right of action

51 But The Mortgage Has Been Accelerated! So??? Loan mods are always offered to people after the mortgage has been accelerated Ask for basis of denial No law forbidding assumptions after acceleration Never seen investor guidelines that forbid assumptions after acceleration Remember an assumption helps the ultimate owner of the loan by giving them more recourse in the event of non payment

52 HAMP Rules & Assumption HAMP Limits when the servicer can insist on unobtainable signatures Encourages servicers to work with homeowners who aren t on the note to process assumptions and delay foreclosures (Unfortunately) suggests that servicers may be able to deny assumptions, based on investor guidelines or state or federal law

53 HAMP Rules On Signature Personal rep of estate can sign (8.9.1) Deceased borrowers don t have to sign (5.7) Servicer can waive signature requirement for mental incapacity, military deployment or contested divorce. (5.7)

54 HAMP RULES For Borrowers Borrower vs. non borrower Probably means person on note versus person not on note Borrower may continue existing TPP or apply for new one (8.9.1)

55 HAMP RULES For Assumptions Requires servicer to stay foreclosure for non borrower while assumption process chugs forward (8.9.2) Surviving homeowner remains eligible for new TPP, even if gets booted out of existing TPP (8.9.3) 4(H) of Mod Agreement provides that transfers and assumptions as allowed by Garn are okay BUT suggests that applicable law or investor guidelines may forbid modification

56 Freddie Mac Guidance Provides for simultaneous modifications and assumptions, after borrower s death, by someone, like a surviving spouse, with an ownership interest in the property B65.12, B65.28 in the Single Family Seller Servicer Guide Points of concern: Can you get a HAMP mod or only a standard mod? What happens in divorce? Language not entirely clear that assumption can t involve new credit screening

57 Fannie Mae Guidance References exempt transactions basically the Garn St Germain exceptions Requires communication with new owners in exempt transactions Loan mod requests for new owners in exempt transactions have to be evaluated as if they came from borrowers See Fannie Mae Lender Letter LL , also Fannie Mae, Transfers of Ownership, Questions and Answers

58 Fha rules HUD has a general policy of free assumability With a credit review Unless the new owner is via devise or descent HUD Handbook Rev 5 Chapter 6 Not quite clear where that leaves divorcees

59 CFPB Guidance CFPB Bulletin (Oct. 15, 2013) Servicers should let successors in interest know what documents they need to provide for communication & assumption Servicers should let successors in interest know what their options are Servicers should develop policies for suspending foreclosure and processing assumption and loan modifications simultaneously

60 DEALING WITH THIS IN DIVORCE Work with the family law attorneys Get disposition of debts and title in family law court: Who is responsible for mortgage? Order assigning rights and responsibilities/ acknowledging assumption of mortgage by remaining spouse? Quit claim deed to remaining spouse Consider consolidating the foreclosure into the divorce proceeding In Re the Marriage of Schweihs, 222 Ill App 3d 887, 584 NE2d 472 (1st D 1991) In Re Marriage of Elliott, 265 Ill App 3d 912, 638 NE2d 1172 (1st D 1994)

61 DEALING WITH THIS IN DEATH Property passes automatically upon death to heirs True whether intestate succession or via a will Trick is getting the servicer to recognize Estate? Title company opinion?

62 DO YOU NEED TO OPEN AN ESTATE? How is the property held? Property held in joint tenancy, tenancy by the entireties, land trust, passes outside probate Is there a will? If so, it has to be filed, but still may not need to open an estate Title insurance is the key Talk to the title insurer what will they require to issue a policy? Bond in lieu of probate? Affidavit of heirship? Coupled with quit claim deeds from other heirs? Affidavit of joint tenancy?

63 How to Raise RIGHT To Assume in Litigation Bankruptcy UDAP Court s equitable powers Breach of duty of good faith and fair dealing ECOA/ FHA Breach of contract FDCPA

64 Bankruptcy cases Servicer required to engage with GSG protected debtor in state mandated loss mitigation procedures, even though debtor was not on the note and mortgage. In Re Smith, 469 B.R. 198 (Bankr. S.D. N.Y. 2012). Non borrowers that are protected under GSG must be allowed to deaccelerate the note. See In Re Jordan, 199 B.R. 68 (Bankr. S.D. Fla. 1996); In Re Curington, 300 B.R. 78 (M.D. Fla 2003); Citicorp Mortg. v. Lumpkin, 144 B.R. 240 (Bankr. D. Conn. 1992); In Re Alexander, 20 Fla. L. Weekly Fed. B 463 (Bankr. N.D. Fla. 2007); see also Johnson v. Home State Bank, 501 U.S. 78 (1991). Mortgage that permits assumption only with lender s approval is equivalent to a due on sale clause prohibited by Garn. In Re Jordan, 199 B.R. 68 (Bankr. S.D. Fla. 1996). Basic principle in bankruptcy that anyone who has an interest in the property should be allowed to cure the arrearages.

65 Udap challenges State UDAP claims: Garn prohibits enforcement of due on sale clause for heirs, divorcees, etc; Lender s refusal to accept payments, give information, or consider assumption constructively accelerates note & mortgage, in violation of Garn; Depending on state law, may be able to raise these refusals as violation of state laws barring unfair or deceptive practices.

66 UDAP misleading and unfair conduct Note and mortgage terms violate federal law if they are due and payable after the death of owner/mortgagor; Not authorized to communicate or won t communicate with heirs/divorcees about the terms, payments or status of the mortgages on their homes, even though they own the home; Refusal to accept payments from heir/divorcee; Refusal to consider new owner for assumption of note/ mortgage; Refusal consider new owner for modification of the existing mortgage on home; Offering new owner loan modification but won t grant one. See McGarvey v. Chase, E.D. CA, 10/11/13 (denying motion to dismiss unfair business practices claim on behalf of class of widows & orphans who own homes but aren t borrowers, and were not processed for assumption simultaneously with modification).

67 Discrimination claims FHA and ECOA Protected class? Women? Age? Disparate impact vs. disparate treatment Getting data Risk: protection only for a subset of the folks with this problem

68 Breach of contract Terms of note & mortgage permit calling due and payable upon transfer only if allowed by applicable law. Servicer s refusal to accept payments, talk to new owners, consider assumption, etc. = actual or constructive acceleration in violation of Garn. Garn prohibits acceleration upon transfer by inheritance, divorce, etc. Acceleration in violation of Garn ( applicable law ) is a breach of contract.

69 What about reverse mortgages? By their terms, are due and payable upon death of borrower. 12 U.S.C. 1701j 3(e)(2) exempts reverse mortgages from the Garn protections

70 HECM regs conflict with statute HECM statute: HUD reverse mortgages must protect spouse from displacement, even if not on the mortgage. 12 U.S.C. 1715z 20(j). But HUD regulations & HECM documents terminate mortgage upon death of mortgagor 24 C.F.R (c); Trigger foreclosures on borrowing spouses

71 Bennett V. donovan HUD s regulation terminating mortgage upon death of borrower violated plain statutory protection for homeowners, including non borrowing spouses. HUD erred in insuring mortgages in reliance on this illegal regulation. Remanded to HUD to determine relief consistent with decision.

72 Remaining issues Mortgages give 3 rd party lenders right to foreclose upon death of borrower. HUD must act to protect spouses & lenders. While HUD is deciding what relief means, what happens to the surviving spouses who are being foreclosed on, regardless of illegal rule?

73 file:///r /NCLC-CL/eReports/update/html/ htm New IRS Guidance Limits Adverse Tax Consequences of HAMP Loan Modifications Involving Principal Forgiveness by Diane Thompson NCLC ereports, April 2013, No. 3 Foreclosures and Servicing, Mortgage Loans IRS Revenue Procedure (Jan. 24, 2013) offers homeowners new options for limiting the tax consequences of principal forgiveness in connection with HAMP loan modifications.[1] This guidance applies to future returns, returns for the 2012 tax year, and returns from previous years. Homeowners may amend previously-filed returns, from this year or any previous years in which they recognized debt forgiveness income from a HAMP loan modification, to take advantage of the Revenue Procedure. Revenue Procedure also discusses the tax implications for investment properties, which are eligible for HAMP Tier II modifications; this article only addresses the implications for resident homeowners. This guidance has the potential to save low-income families millions or even billions of dollars in tax consequences, as well as the stress and strain of facing IRS collection actions. In a HAMP Principal Reduction Alternative (PRA), a portion of the mortgage principal is forgiven over time. For many families, the potential tax consequences of a HAMP PRA amounts to tens of thousands of dollars and several months of income more than any family is likely to be able to spare, much less a low-income family recently facing foreclosure. Practitioners advising clients with HAMP PRA loan modifications can maximize the benefit of those loan modifications and minimize the adverse tax consequences by providing homeowners with information about IRS Revenue Procedure How the IRS Treats Forgiven Debt The Internal Revenue Code generally treats forgiven debt as taxable income in the year in which it is forgiven.[2] The statute provides for some exceptions to this general rule: debt forgiven in bankruptcy forgiven debt to the extent that the taxpayer is insolvent or Qualified Principal Residence Indebtedness (QPRI).[3] file:///r /NCLC-CL/eReports/update/html/ htm (1 of 5)9/6/2013 2:28:01 PM

74 file:///r /NCLC-CL/eReports/update/html/ htm Whether the exclusions apply is measured at the time the debt is forgiven. There is also an exception for debt that is forgiven as the result of government payments, under what is called the "general welfare doctrine." Generally, in order to take advantage of these exceptions, homeowners must file a long form 1040 and attach Form 982. Homeowners who fail to do this run a substantial risk of facing a dunning notice from the IRS: forgiven debt is reported by loan servicers to the IRS on 1099-C's, and the IRS automatically cross-checks 1099-C's against 1040's it receives.[4] The HAMP Principal Reduction Alternative Under HAMP's Principal Reduction Alternative (PRA), the amount of principal forgiven is calculated at the outset of the modification, but is recognized in three equal installments, on the first three anniversaries of the permanent modification.[5] As a result, a principal modification entered into this year could result in taxable income for 2014, 2015, and Investors are paid by the U.S. Treasury for forgiving principal under PRA. The investor incentive payments are calculated based on a matrix of how delinquent the mortgage is at the time of the modification (incentive payments are larger for loans that are less than six months delinquent) and what the post-forgiveness loan-to-value ratio is (more money is given for principal reductions that bring the loan-to-value below 115% down to a 105%).[6] These investor incentives range from a low of 18 cents on the dollar to 63 cents on the dollar of principal forgiven. Revenue Procedure Investor Incentives Excluded from Taxable Income The Revenue Procedure reaffirms prior guidance: the amount of the forgiven principal is excluded from income to the extent of the investor incentives.[7] Servicers are not to include this amount of the forgiven debt in the 1099-C's they issue to borrowers.[8] Unfortunately, many homeowners are more than six months delinquent when their trial modification is started,[9] and thus will only see a small reduction in their potential tax bill under this exclusion. Servicer Reporting Under Revenue Procedure , servicers are required to report the principal forgiven in a lump sum at the time the permanent modification is finalized, excluding the amount attributable to investor incentive payments.[10] file:///r /NCLC-CL/eReports/update/html/ htm (2 of 5)9/6/2013 2:28:01 PM

75 file:///r /NCLC-CL/eReports/update/html/ htm Homeowner's Election Homeowners may elect whether to treat any remaining principal reduction (after the exclusion of the investor incentives) as income in the year they enter into the permanent modification or as the principal is reduced on the anniversary date of the permanent modification.[11] Most homeowners will minimize tax consequences if they recognize the full amount in the year when the permanent modification is entered into, and not as the debt is forgiven over time. Most homeowners receiving a permanent modification with principal reduction will be able to exclude a significant portion of the debt forgiven under either the QPRI exception or the insolvency exception in the year when the permanent modification is entered into, but may not be able to take advantage of either of those exceptions in future years. Additionally, recognizing the entire amount forgiven in year 1 simplifies the homeowner's accounting and tax preparation costs. The homeowner will only need to file the long form 1040 and Form 982 once, not three times, and only once need obtain sophisticated tax advice on the treatment of the forgiven debt. Additionally, for homeowners seeking to use the insolvency exception, recognizing the forgiven debt as income in the year when the permanent modification becomes effective means that only one valuation of their assets (including the house) need be done, not three. In many cases, homeowners may be able to use the servicer's valuation of the home, done as part of the evaluation for the HAMP modification, when recognizing the forgiven debt in year 1, but will not be able to do so when spreading the recognition out over three years. Both QPRI and the insolvency exception may not be available to homeowners beyond year 1. QPRI is currently set to sunset at the end of this year; without congressional action, it will not be available for homeowners in tax years after 2013.[12] Insolvency does not have the same hard cutoff as QPRI, but, for most homeowners, recognizing the full amount of the debt forgiven as income when the principal modification is finalized will maximize the availability of the insolvency exception. If the homeowner spreads out recognizing the debt as income over three years, each year the homeowner will have to redo the insolvency calculation, valuing anew all of her assets and liabilities. Over the three years that the principal reduction is applied to the balance of the mortgage, the homeowner's balance sheet is likely to improve either because housing prices rebound or because the homeowner is paying down her debt or, most likely, both. The result is that in each subsequent year, the homeowner is less and less likely to be able to exclude the forgiven debt under the insolvency exception. If the homeowner is fortunate enough to pay down other debt, come into a small inheritance, or build up savings, those small gains could well be wiped out by the tax consequences. Only homeowners who are not insolvent and are not eligible for the QPRI exception and expect to pay taxes on the forgiven principal of their loan should elect to recognize the income over three years. What Happens If the Homeowner Loses Good Standing file:///r /NCLC-CL/eReports/update/html/ htm (3 of 5)9/6/2013 2:28:01 PM

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