'Underwater' Homeowners Likely to Face New Tax Bill

By Mary Shanklin
Posted in the Orlando Sentinel on December 17, 2013

Starting next month, about 130,000 Orlando-area homeowners with "underwater" mortgages are
likely to face a new tax bill if they sell their house, modify their mortgage or lose their home in
foreclosure.

A 2007 federal law that waived income taxes on unpaid mortgage debt is almost certain to expire
Dec. 31.

"It's potentially going to put a lot of people in harm's way because they're going to have a huge
tax impact," said Orlando bankruptcy lawyer Cynthia Lewis. People barely hanging on
financially could be forced to default on car payments or medical bills, Lewis said.

Without the waiver, homeowners will have to pay income taxes on any mortgage amount
forgiven by the lender, including a foreclosure. Homeowners also will have to pay tax on
mortgages that are unpaid because of a short sale or a loan modification, which lowers monthly
payments. A typical homeowner who sells a house for $100,000 but still has a $200,000
mortgage could face a tax bill of $28,000.

Last year, U.S. Sen. Bill Nelson's office played a role in extending the waiver, but a spokesperson
for the Florida Democrat said Congress won't extend it into 2014.

Nelson said the expiration of the tax break for underwater homeowners is unfortunate.
"We shouldn't punish homeowners whose house has depreciated through no fault of their own. If
someone is $30,000 underwater on their mortgage, and the bank cancels that debt in a short sale,
they'll end up having to pay the IRS taxes on the $30,000. That just doesn't seem fair."

The Mortgage Forgiveness Debt Relief Act has been extended twice, but Senate staffers say
mortgage defaults are no longer a big economic issue for the country as a whole. In Central
Florida, however, the tax could touch many lives.

Orlando homeowner Julius Ludwin, 82, is a few months behind on mortgage payments and
trying to work out a mortgage modification with Wells Fargo. Dependent mainly on Social
Security for income, Ludwin said he would be unable to pay any taxes on unpaid debt if he gets
the loan modification he's seeking.

"We can't pay any taxes. We have no money," he said. "They'll have to try to do something about
that. I thought it was supposed to be easier now to get by."

Homebuyers don't report loan proceeds as income because they are expected to repay the loan.
Once that debt is forgiven, however, the Internal Revenue Service considers it income.

Orlando tax attorney Stephen Looney of the Dean Mead law firm said the toughest thing about
reinstating the tax is that homeowners are unlikely to see it coming. Even commercial investors
are often unaware of tax penalties on unpaid debt, and it's even more likely that homeowners will
be blindsided, he said.

"One of the worst parts is that it will come as a surprise to most homeowners," he said. "All of a
sudden, they will have a tax bill they haven't planned for, and it may not be insubstantial."

The IRS may work out a payment plan, but it's less likely to negotiate down the amount owed, he
added.

In Metro Orlando, more than a third of the houses with mortgages - about 130,000 - were
financially underwater in the third quarter, according to a recent report by Zillow.

As home-sale prices have risen during the second year of the region's housing recovery, an
increasing number of homeowners have been able to sell and break even - or even make a
profit. A year ago, about half of the region's mortgaged houses were underwater. This time next
year, an estimated 29 percent of Orlando-area houses will carry more debt than they are worth,
according to Zillow.

So far during the real-estate downturn and recovery, banks have largely forgiven unpaid
mortgage debt on short sales, foreclosures and loan modifications, Lewis said. But the federal
government may be much less likely to waive taxes that will now be owed on unpaid mortgage
debt.

"It changes the nature of the debt from something that is negotiable to something that is a lot less
likely to be negotiated," she said.

mshanklin@tribune.com or 407-420-5538

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