Anne Arundel Co. taxing forgiven debt on short sales
Should short sales be taxed differently than "regular" home sales?
Anne Arundel County thinks so. It's levying its recordation tax on the sales price plus any forgiven debt, and the Anne Arundel County Circuit Court is doing the same with state and county transfer taxes.
The county says it's not a policy change and it's just following the law. But real estate agents say it wasn't collecting taxes this way until last week, and that they discovered it the hard way -- by not being able to record sales that had already been to the settlement table.
A title industry trade group says it knows of no other government in the country handling short sales in this way. (Read more about the argument in today's story.)
You probably know what a short sale is if you're reading a blog with a name like "Real Estate Wonk," but just for form's sake, a quick explanation: It's a home sale with a contract price that's less than what the seller owes on his or her mortgage, and the lender is allowing it to go through without demanding all of the difference at closing.
The thing is, lenders are frequently leaving their options open on how they're going to deal with that debt, approving short sales but reserving their right to go after the borrower later. So says Andrew Levy with the Crofton-based Capitol Title Insurance Agency.
That "might or might not" situation isn't enough to get a short sale off the hook for being taxed on forgiven debt in Anne Arundel. The county's controller, Richard Drain, said parties to the sale need to provide solid documentation -- such as a promissory note -- to prove that the lender isn't going to forgive and forget.
The county is offering another way, he said. It will tax the sale on the fair-market value if the parties provide documentation, such as a recent appraisal, along with a hardship letter from the seller about his or her financial difficulties.
But the real estate industry is up in arms about the entire thing. Real estate agents say the sales price is a negotiated deal -- negotiated out the wazoo, usually, since lenders are involved -- and ought to be what the county taxes. And they think the hardship-letter requirement for the exemption violates sellers' privacy.
So: Are buyers getting a below-market steal on short sales, unfairly lowering the amount of taxes cash-strapped local governments can collect? Or is Anne Arundel overreaching? The Maryland Attorney General's office expects to weigh in, but in the meantime, let's hear what you all think.
Sign up for the At Home newsletter 
Comments
I'm puzzled. I can see if the bank forgives the difference between the sale price and mortgage balance as there being income tax implications for the seller. And I can see if the bank just writes off that difference like any other bad debt as their being income tax implications for the bank. But I don't see how either of those situations should apply to the actual sale of real property. It should apply at income tax time, no?
Posted by: Paul | January 21, 2010 10:37 AM
The problem is semantics.
The SALES people refer to the lenders actions as "forgive" when all it ever is or ever was or ever shall be is a "suspension".
The criminal part of all this is that the RE pro's have known this all along but have artfully avoided openly and fully informing their clients let alone pressing the issue.
1099 anyone?
Posted by: MrRational | January 21, 2010 11:29 AM
Not sure where "Mr. Rational" is getting his information. When we list short sales, we always provide the seller's a list of all the unpleasant things that can follow from a short sale. And I think any competent, ethical agent would do the same.
Frankly, the issuance of a 1099 for forgiveness of debt is pretty far down the list of things to be concerned with.
Unless the the short seller was using their home equity like a piggy bank, up to $2 million in debt forgivness is non taxable. (see link http://www.irs.gov/individuals/article/0,,id=179414,00.html )
Much worse is the denial of a short sale entirely, which results in foreclosure or the requirement that the borrower sign notes which continue their obligation to make payments on a house they no longer own for years after the sale.
Posted by: Mike Davis | January 21, 2010 12:35 PM
Is Anne Arundel going to start taxing consumers on household stuff they buy on sale? If I buy a pair of jeans for $20 and they were originally $75, should I pay taxes on the $55?
I realize that's a simplistic example, but buyers already have so many incentives to avoid short sales (uncertainty, time, condition of property, etc.) that adding this one makes it even harder for owners to sell these distressed homes.
Posted by: Justine | January 21, 2010 2:41 PM
I think some of the readers are misinterpreting this. This has to do with recordation tax, not 1099 income tax. Yes, the lender will issue a 1099 to the seller for the loss. Depending on the sellers circumstances, the income will be forgiven. Look up the IRS tax law and you can determine your eligibility.
Say the seller owes 300k on the mortgage and the buyer gets the property for 200k. I am not sure what the transfer tax is in AA County, but the total transfer taxes and doc stamps should be no more than 3.3% total. All this means is the buyer will pay the transfer tax on what the seller owes on the mortgage. This should amount to about $3,000 in additional taxes when taking the 100k in consideration. There is no 1099 or income taxes given by the County. Only the lender will give the 1099 to the seller once the home closes for the lower price.
My opinion is that this is absolutely ridiculous. Most of the homes that are selling as short sales are properties that are now underwater. That means they owe more than what the property is worth. If you owe 300k and the homes are selling for 200k, then guess what? The home is worth 200k. If the home was worth more, then most likely they would sell the home for more. This is just another bureaucratic incompetency and shows the Gov't has no clue what they are doing. I bet this has more to do with the County trying to get additional revenue for their budget deficit. I don't see how this can be enforced as it is illegal in my opinion to charge more in taxes than the sales price.
What if it was not a short sale? What if the homeowner bought ten years ago and owed 180k and sold for 200k? It should not matter what the seller owes on the home when determining transfer taxes, as they are based on the SALES price. The County wants to keep assessments higher because they know if they are come down, their property tax revenue will fall too.
Posted by: Frank Rizzo | January 22, 2010 5:31 AM
Wow, this is absolutely ridiculous. The counties' interpretation defies logic. Government is way overreaching. As a buyer, this is enough for me to avoid that county. If they would try a game like this what else would they try? AA is not a place I would want to live.
Posted by: Viper | January 22, 2010 8:00 PM
The real estate and housing industry has lead us out of the last several recessions. We have to be careful to avoid doing anything that could prevent housing from selling to people who can afford them.
Posted by: John Howard | July 31, 2010 4:53 PM