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Infographic: Strategic defaulters rushing to beat mortgage debt relief deadline
(5/30/2012) A growing number of struggling homeowners are taking the "strategic default" approach to foreclosure to save thousands of dollars in taxes before a special tax benefit expires this year.
In a survey of its clients considering foreclosure, YouWalkAway.com found 34 percent of them motivated by the Mortgage Debt Relief Act (MDRA) which expires Dec. 31 2012.
Those surveyed said the expiration date is motivating them to initiate foreclosure sooner rather than later.
MDRA is a federal tax law that allows qualified taxpayers to exclude from taxation, income derived from the forgiveness or discharge of debt associated with a mortgage on a principle residence.
In a short sale, foreclosure or other distressed home transaction, the difference between the amount owed on the mortgage and the amount of the final sale, was considered taxable income until MDRA was enacted in 2007 to provide tax relief.
State tax rules vary on the subject.
A strategic default occurs when a homeowner, who can afford to pay the mortgage, purposely halts mortgage payments to force the lender to begin the foreclosure process, which can result in taxable income without MDRA tax relief.
Homeowners engage in a strategic default for a variety of reasons.
To induce relief from federal, state and lender programs available only to those who are late on their mortgage payment.
Because the homeowner owes more than the home is worth and is so far "underwater" he or she doesn't expect equity growth to tip the scale in his or her favor for years, if ever.
A calculated risk that renting is a better deal than owning in today's market and that the homeowner can overcome a foreclosure's impact on their creditworthiness in a few years and buy anew.
Add MDRA's expiration to the list.
Beating the clock
Many homeowners believe they may eventually face foreclosure and are trying to avoid being twice victimized by both foreclosure and the extra tax bill. The law expires in six months and the foreclosure process can take much more time.
Once it expires, for those hit with a huge tax bill, bankruptcy may be the only alternative.
"It has been argued that their inability to pay an inflated mortgage will simply morph into an inability to pay colossal tax debt. This will in turn lead to further defaults of other lines of credit or an influx of bankruptcy filings. A massive amount of bankruptcy filings is not the correct way to fix the economy, nor will it provide any aid in the housing recovery," said YouWalkAway.com CEO Jon Maddux.
YouWalkAway.com is a San Diego, CA foreclosure agency and consumer law advocate that assists clients through foreclosure and other mortgage workouts. The company said 78 percent of those who responded to the survey are strategic defaulters and, among that group, 74 percent would qualify for MDRA relief today.
Struggling homeowners, however, are pragmatic about the perpetual lame-duck Congress coming to their rescue.
First effective Jan. 1 2008 MDRA also included a provision that benefited perhaps more taxpayers than the forgiven debt provision. It also allowed all homeowners tax deduction for government or private mortgage insurance. Legislators allowed that provision to expire last year without so much as a filibuster.
"The survey results are not surprising," said Maddux.
"Although not extending the MDRA may slow strategic defaults temporarily, the housing recovery will slow and eventually the economy as a whole will suffer. If this act does not pass, we as a country will feel the effects years down the road," he said.
"Most strategic short sales will stop immediately, because of the homeowner's fear of a getting hit with a huge tax bill. If the act is not extended, there will be massive tax consequences owed come April 2014," he added.
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