What is the Mortgage Debt Relief Act?

The Mortgage Forgiveness Debt Relief Act (MDRA) was a government bill that offered relief to most homeowners who would normally owe taxes on forgiven debt after performing a short sale. Under previous US law, when debt is forgiven by a commercial lender (Bank of America, Chase, US Bank etc.), that debt would normally require the borrower to include the amount forgiven as taxable income on tax returns. This would mean the borrower would have to pay income taxes on their forgiven debt. When the MDRA was in place, a borrower did not have to pay income tax on forgiven debt in the most common short sale scenarios. The Act initially became law in 2007 and expired in 2014. Near the end of 2015 the act was re-established, became retroactive and then expired in 2016. Laws and guidelines have been provisioned in California to preemptively protect California homeowners now that the MDRA has expired.

For example, if the lender forgives $50,000 of debt to the homeowner after the completion of a short sale, under traditional tax laws that $50,000 is considered income. If your combined federal and state marginal tax rate is 25%, you would then owe $12,500 in taxes. Under the Mortgage Forgiveness Debt Relief Act, you would have been allowed to exclude from income the discharge of debt, and therefore not have to pay the taxes associated with it.

California Homeowners are Still Protected

California Senator Barbara Boxer has clarified with the IRS that under California guidelines, those who perform a short sale on their primary residence are assured that no federal tax penalties will be incurred even though the Mortgage Debt Relief Act has expired. Technically speaking, under the anti-deficiency provision of Code of Civ. Proc. 580e, the debt would be a non-recourse obligation and for federal income tax purposes the homeowner will be considered not having COD income. Furthermore, the California Franchise Tax Board also states that distressed California homeowners who short sale are protected against any state income tax when the sale of the home is completed. For more information and details about exemptions, please call us at 1-800-760-9156.

If your tax lingo is up-to-date, you can read more about how the IRS and California deal with short sale debt at the California Franchise Tax Board website.

You can also read the IRS response to treating non-recourse debt forgiveness at the IRS Website.