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Taxes and loan modifications: what’s the impact?

How does a loan modification effect a person’s taxable income?

1.      The general rule is that when debt for which a person is liable is canceled or forgiven, the canceled amount must be included in a party’s reported income.

Generally, if a debt for which a person is personally liable is forgiven, the forgiven amount must be included in that person’s income.   The IRS defines debt to include any indebtedness for which one is personally liable, or subject to which one holds property.  If a person is not personally liable for a debt, the cancellation income will need to be included if a person retains the collateral and either: (1) the lender offers a discount for the early payment of the debt, or (2) the lender agrees to a loan modification that results in the reduction of the principal balance of the debt.

Taxes2.      There is an exception to the general rule for debt incurred to finance the purchase, construction or substantial improvement of a person’s residence.

A person can exclude canceled debt from income if it is qualified principal residence indebtedness.  Qualified principal residence indebtedness is any mortgage a person took out to buy, build or substantially improve his or her main home.  The mortgage must be secured by the main home.  A person’s main home is the home where he or she ordinarily lives most of the time.  A person may only have one main home at any one time. The IRS has not provided guidance on what it considers a “main home,” but does say it will look at the facts and circumstances in every case.  A person is limited to excluding $2 million of qualified principal residence indebtedness.  If a person excludes canceled qualified principal residence indebtedness and continues to own the home after the cancellation, the person must reduce the basis of the home by the amount of the canceled indebtedness, but may only reduce the basis to zero.  The legal authority for this memo comes from IRS Publication 4681, except where other authorities are cited.

Photo: cooldesign

Forecosures to be “up” in 2011

According to a recent article, many experts are predicting that the foreclosure crisis will continue through 2011.  Currently, there are about 5 million borrowers at least 2 months behind on their mortgage payments.

Federal Trade Commission’s new rules limits up-front fees for loan modification services

federal-trade-commissionOn November 19, 2010, the Federal Trade Commission (FTC) issued 16 C.F.R.  Part 322, the Mortgage Assistance Relief Services Rule (MARS) concerning providers of mortgage relief service.  While many relief providers are legitimate, “At a time when many Americans are struggling to pay their mortgages, peddlers of so-called mortgage relief services have taken hundreds of millions of dollars from hundreds of thousands of homeowners without ever delivering results,” FTC Chairman Jon Leibowitz said.  Unlike an attorney assisting a client  in a loan modification or short sale effort, many mortgage relief services do not have a good understanding of the consistently changing rules and laws (both state and federal) involving mortgages and foreclosures and are not subject to code of ethics.

The MARS Rule is designed to protect distressed homeowners from these mortgage relief scams.  The most significant new rule under MARS is that non-attorneys offering mortgage relief services may not collect any fees until:

  1. The company has provided the consumers with a written offer from their lender or loan servicer that the consumer decides is acceptable.


  1. The company has provided the consumers with a written from the lender or loan servicer describing the key changes to the mortgage that would result if the consumer accepts the offer.


  1. The company must remind the customer of their right to reject the offer without charge.


The MARS Rule also requires mortgage relief services to disclose key information to customers, including that the company is not associated with the government or the customer’s lender and that the lender may not agree to change the customer’s loan.   In addition, it the company tells the consumer to stop paying their mortgage, they must inform the consumer that this could cause them to lose their home and damage their credit rating.

In addition to the mandatory disclosures, the MARS Rule prohibits mortgage relief companies from making false or misleading claims about services, including claims about:

  • the likelihood of consumers getting the results they seek;
  • the company’s affiliation with government or private entities;
  • the consumer’s payment and other mortgage obligations;
  • the company’s refund and cancellation policies;
  • whether the company has performed the services it promised;
  • whether the company will provide legal representation to consumers;
  • the availability or cost of any alternative to for-profit mortgage assistance relief services;
  • the amount of money a consumer will save by using their services; or
  • the cost of the services.

In addition, the rule bars mortgage relief companies from telling consumers to stop communicating with their lenders or servicers. Companies also must have reliable evidence to back up any claims they make about the benefits, performance, or effectiveness of the services they provide.

Attorneys are exempt from this new rule as long as they are engaged in the practice of law, licensed in the state in which the consumer or home is located, and comply with the State’s ethics rules.  These are requirements that any practicing attorney should meet anyway.  In addition, and fees attorney’s collect will be placed in a client’s trust account and only withdraw for work performed in accordance with the retainer agreement the client has signed.

All provisions of the rule except the advance-fee ban will become effective December 29, 2010. The advance-fee ban provisions will become effective January 31, 2011.



Coming January 31st, FTC to limit loan modification scams

According to this article from the LA Times, the Federal Trade Commission (FTC) is starting to “clamp down” on phony loan modification companies.  Essentially, starting January 31st, loan modification companies will be prevented from getting upfront fees.  The evaluation by the FTC is simple: “[i]f a [loan modification company] seeks to charge you anything or collects money upfront, it will be in violation of federal law and subject to harsh penalties.”  For loan modification companies to continue, they will have to “contact your lender or servicer and give you a written proposal describing the key changes to your mortgage terms that the note holder [usually your lender] is willing to make before any more money can be collected in advance.”  In essence, loan modification companies are will be required to complete a pre-loan modification modification, before they can execute a final loan modification, at which point, they may be paid for their services.

The articles goes on to report that attorneys are largely exempt from the law:

The only exception will be for lawyers, who typically require retainers before they begin negotiating on a client’s behalf. They will be permitted to collect retainer fees for modification efforts but only if they deposit the money into “client trust accounts” under state bar regulations. Lawyers who charge advance fees also must be licensed by state authorities and be in compliance with state laws and regulations governing professional conduct.

This new regulation from the FTC is bound to frustrate many loan modification scams that seek to obtain funds from clients, but then provide nothing in return.  Fortunately, the FTC leaves in place law firms to handle upfront fees.

Loan modifications for a second mortgage: what are my options?

Often times, people who have second mortgages believe they are essentially shut out from the loan modification option.  This may not be true.  The government has a program which may assist those who wish to modify their current loan, but who also have a second mortgage.  This article discusses the options in general detail.

BSpencerhomeFor even more information, look at the government’s website here.

Congress grills banks for their loan modification practices

According to this article from Reuters, banks are still hesitant to carry through with loan modifications.

Seattle real estate prices jump, but market still soft

The month of May showed a mixed bag of real estate sales statistics for the Seattle area, with an increase in pricing, but softening of inventory.  Apparently, the small bounce in pricing is related directly to the impact of the tax credited offered by the federal government.  Now that it has expired (or is expiring as the last sales close), it will be interesting to see the impact.

Here is the full story.

Interesting article on how to purchase a foreclosure or short sale home

The above link provides an exhaustive outline of what someone interested in purchasing a foreclosure/short sale home should consider.

Housing market continues to struggle

This article in Business Week outlines the ongoing (and troubling) picture of the US housing market:


Suit filed against Bank of America over alleged failure to disburse TARP funds

OLYMPUS DIGITAL CAMERAA Seattle law firm, Hagens Berman Sobol & Shapiro, has filed a lawsuit against Bank of America over its apparent failure to satisfactorily distribute TARP funds to stem foreclosures.
According to a press release by Hagens Berman, Bank of America has made an “affirmative decision to slow the loan modification process for reasons that are solely in the bank’s financial interests.”
It will be interesting to monitor how this suit develops, as it strikes at the core issue of whether the government’s injection of capital into the banking market actually resulted in a positive result.