The next wave in the housing crisis

[Col. Crackpot]

Slow day at the bank yesterday. I was chatting with my assistant manager and one of my bankers about tax season, and somehow the topic veered (as it often does lately) to credit defaults, foreclosures etc. We talked for a moment about debt settlement. What a lot of people don't know is that if you negotiate a settlement with a creditor (bank, credit card company, collection agency) for a figure less than the actual debt, the difference is considered income by law and you are issued a 1099.

Apply this to current bumper crop of lender short sales. A financially destitute individual falls behind on their $200,000 mortgage, and the lender agrees to a short sale for $125,000. All is well and good until tax season when the former mortgagee gets a 1099 for $75,000, and suddenly discovers that instead of a tax refund of a few grand to keep them afloat for a few months, they owe the federal government $15-20 K.

I called a friend and accounting, who pretty much confirmed this. Not only that but you cannot roll back taxes into a bankruptcy filing. SCARY SHIT. And it is just now about to hit the fan. Mark my words.

[Edi]

This is going to look like a fucking massacre when these things come due. You're in one of the prime seats to watch this unfold. Any predictions on just how bad it's going to be? I'd rather have some advance warning on what to expect if at all possible and I'm certain many others would as well. Unlike me, the Americans here have more than an academic interest in this.

[Alferd Packer]

Man, that is scary. I suspect, though, that you could establish some kind of payment plan with the IRS to pay of these back taxes in a reasonable amount of time? After all, you've already lost your house, so, provided you still have a job, the best they could do is garnish your wages. If you don't have a job and no assets of value that they can seize, what exactly can they do? Throw you in jail?

[Tiriol]

Man, that is scary. I suspect, though, that you could establish some kind of payment plan with the IRS to pay of these back taxes in a reasonable amount of time? After all, you've already lost your house, so, provided you still have a job, the best they could do is garnish your wages. If you don't have a job and no assets of value that they can seize, what exactly can they do? Throw you in jail?

Worst come to be, yes. They can jail you in the worst case, if I've understood things correctly. Of course any sane government tries to avoid that and to make a payment plan instead - especially in a time like this.

[Solauren]

Speaking as someone that works for a government tax agency / ministry, I have to say this;

It's our general policy to only go after jail time (etc) if we can't work out a payment schduele for taxes due, or if payments are missed. We've even been known to toss other stuff out the window to accomidate this, as long as we get the taxes paid.

However, when it does comes to that, we go for the juggler, and we don't mess around.

This could, if handled properly, not be as bad a disaster as it first seems. There are numerous ways to handle this that don't have to end in an ecomonic blood-bath.

i.e Void all the 1099s assoicated with this. Not being Americna/affiliated with the IRS, I don't know if this is feasible.

i.e Long term payment plans with 0 to 1% interest. $100 over 200 months would pay off 20,000. That's about 16 years, 7 months approximately. With the option of paying off more if you get the money to do so, obviously.

i.e Adding it on to your mortgage, which would have the same effect as the Long Term payment plan, but take longer due to interest.


Actually, this kind of criss presents interesting opportunity's. (Yes, the evil being in me is surfacing for this one, but...). You could also include options like monthly blood donations counting towards the loan (blood banks are always screaming they need it), community service and the like.

[Kodiak]

However, when it does comes to that, we go for the juggler, and we don't mess around.

Damn, I knew some people don't like jugglers but this is ridiculous! Do you prefer acrobats?

As I understand it, the Fed has all the time in the world for you to pay back your taxes and they can and will garnish one's wages to make up for it. This will be some hard-core sadness for a lot of folks. One thing that's going to come back and bite ME in the ass is that when I got laid off on Dec 11th last year they handed all of us a check for 60 days pay, a little more than 10% of our annual. And since we got laid off in December, guess when we get to pay taxes on that little gem? Right. fucking. Now. Thank you Uncle Sam, you child molestor.

[Col. Crackpot]

This is going to look like a fucking massacre when these things come due. You're in one of the prime seats to watch this unfold. Any predictions on just how bad it's going to be? I'd rather have some advance warning on what to expect if at all possible and I'm certain many others would as well. Unlike me, the Americans here have more than an academic interest in this.

it's something that could be fixed with the right legislation. tax credits, deferments and the like. The IRS has to realize that the bulk of this will be un collectible.

What scares me is that tax refunds drives Q1 consumer activity. The effect on the whole economy (besides the giant crushing debt thrown on the shoulders of the destitute) will be severe. You guy know me, and I'm the opposite of alarmist. This makes me nervous.

[The Duchess of Zeon]

Oh brilliant. This will probably be only fixed ex post facto, since Congress and the Spoils System-appointed upper level officials in the departments seem utterly ignorant of it, the price we pay for the lack of a professional civil service (we desperately need one-- I believe it's probably impossible to run a country in the modern economy on the spoils system), but by the time that happens the economy will have been stepped on by Godzilla by the chaos this causes.

[TrailerParkJawa]

Here is a link to the IRS website discussing this situation:

http://www.irs.gov/newsroom/article/0,, ... 34,00.html

If I'm understanding it correctly then if you are bankrupt or invsolvent you are exempt from the difference being treated by income. What I'm not clear on is does the Mortgage Forgiveness Debt Relief Act of 2007 give the everyone else a pass.

EDIT:

This link leads me to believe that most people are actually okay if you short sale because there is a $1,000,000 exclusion now.

http://www.irs.gov/individuals/article/ ... 14,00.html

[The Duchess of Zeon]

Yeah, I just found that too. Apparently Col. Crackpot's co-workers weren't aware of that; it was passed on 20 December 2007 and should cover all of the people filing this year, which puts us in a considerably better position. Jesus christ, though, for an hour or so it looked like a vision of the apocalypse, but further research shows we've clearly at least managed to avoid this.

[Col. Crackpot]

Yeah, I just found that too. Apparently Col. Crackpot's co-workers weren't aware of that; it was passed on 20 December 2007 and should cover all of the people filing this year, which puts us in a considerably better position. Jesus christ, though, for an hour or so it looked like a vision of the apocalypse, but further research shows we've clearly at least managed to avoid this.

If I sold my home at a loss and the remaining loan is forgiven, does this constitute a cancellation of debt?
Yes. To the extent that a loan from a lender is not fully satisfied and a lender cancels the unsatisfied debt, you have cancellation of indebtedness income. If the amount forgiven or canceled is $600 or more, the lender must generally issue Form 1099-C, Cancellation of Debt, showing the amount of debt canceled. However, you may be able to exclude part or all of this income if the debt was qualified principal residence indebtedness, you were insolvent immediately before the discharge, or if the debt was canceled in a title 11 bankruptcy case. An exclusion is also available for the cancellation of certain nonbusiness debts of a qualified individual as a result of a disaster in a Midwestern disaster area. See Form 982 for details.

From my understanding this act does not guarantee that debt cancellation from a short sale is excluded. Yes if you roll it into a chapter 11 filing immidiately (which i assume would mean the end of the tax year) and Yes if you are deemed insolvent. From my reading of this (take with a grain of sat, I'm a banker not a CPA) a great many people may be on the hook still. I need to do a little more research. I have a friend who manages an H&R Block branch. I'll ask.

[Glocksman]

Here is a link to the IRS website discussing this situation:

http://www.irs.gov/newsroom/article/0,, ... 34,00.html

If I'm understanding it correctly then if you are bankrupt or invsolvent you are exempt from the difference being treated by income. What I'm not clear on is does the Mortgage Forgiveness Debt Relief Act of 2007 give the everyone else a pass.

EDIT:

This link leads me to believe that most people are actually okay if you short sale because there is a $1,000,000 exclusion now.

http://www.irs.gov/individuals/article/ ... 14,00.html

Thank God.
I filed chapter 7 bankruptcy last April due to medical bills and obscene CC debts occurred from using the CC's to live on while off work due to my heart surgery.

Adjusting to a life without credit is difficult enough (but manageable) without worrying about paying taxes on the $20+K of forgiven debt.

[Admiral Valdemar]

No. The scary shit is around 2010 when the bulk of the ARMs start coming up for renewal. That'll be fun to watch.

[Ariphaos]

If I sold my home at a loss and the remaining loan is forgiven, does this constitute a cancellation of debt?
Yes. To the extent that a loan from a lender is not fully satisfied and a lender cancels the unsatisfied debt, you have cancellation of indebtedness income. If the amount forgiven or canceled is $600 or more, the lender must generally issue Form 1099-C, Cancellation of Debt, showing the amount of debt canceled. However, you may be able to exclude part or all of this income if the debt was qualified principal residence indebtedness, you were insolvent immediately before the discharge, or if the debt was canceled in a title 11 bankruptcy case. An exclusion is also available for the cancellation of certain nonbusiness debts of a qualified individual as a result of a disaster in a Midwestern disaster area. See Form 982 for details.

From my understanding this act does not guarantee that debt cancellation from a short sale is excluded. Yes if you roll it into a chapter 11 filing immidiately (which i assume would mean the end of the tax year) and Yes if you are deemed insolvent. From my reading of this (take with a grain of sat, I'm a banker not a CPA) a great many people may be on the hook still. I need to do a little more research. I have a friend who manages an H&R Block branch. I'll ask.

You missed the bolded one. It leaves a number of idiots with multiple residences on the hook, but most of the country is fine I would imagine.

[His Divine Shadow]

You know when my parents who run a seasonal company sometimes cannot pay their mortage (sometimes, like during winte, money can be tight), they tell the bank they cannot or would rather not pay it now but later, say 6 months or so. The bank just gives them this extension without any fuss or penalty.

Ofcourse they do this because they have been steadily paying off their loans for a loong time and have paid some in full already and are thus trusted and reliable customers. But it seems like a solution that could be used more than just foreclosing people who cannot make a payment, certainly less destructive.

Ofcourse I am totally fucking ignorant on economics so maybe something like this already exist, or maybe it's a stupid, stupid idea?

[Col. Crackpot]

You know when my parents who run a seasonal company sometimes cannot pay their mortage (sometimes, like during winte, money can be tight), they tell the bank they cannot or would rather not pay it now but later, say 6 months or so. The bank just gives them this extension without any fuss or penalty.

Ofcourse they do this because they have been steadily paying off their loans for a loong time and have paid some in full already and are thus trusted and reliable customers. But it seems like a solution that could be used more than just foreclosing people who cannot make a payment, certainly less destructive.

Ofcourse I am totally fucking ignorant on economics so maybe something like this already exist, or maybe it's a stupid, stupid idea?

That is called a forebearance, and it is quite common. The problem with a forebearance is that interest continues to accrue, and unless arrangements are made to asses the interest charges at the end of the note or do a re amortization of the note it just delays the inevitable. Often times banks will accept forebearance and do just that, spread the delinquent interest over time of back load the note.

[Kanastrous]

Does a bank's own creditworthiness take a hit if they extend forebearance to too many people?

[aerius]

Does a bank's own creditworthiness take a hit if they extend forebearance to too many people?

It should, but I don't think it does anymore under the new rules. For example, a loan is usually considered to be in default once the payments fall behind by 3 months, quite a few banks have now pushed that out to 6 months or even 9 months, since if a loan isn't in default they can claim it as an asset at its full value. My guess is the banks will do anything they can to fudge their balance sheets to the plus side, and I wouldn't be surprised if they extend forebearance to lots of people they shouldn't.