Short Sales Fall Out of Favor as Tax Penalty Looms

Mortgage servicers and troubled homeowners may be losing faith that Congress will pass legislation saving borrowers from paying a tax penalty when they do a short sale.

The number of short sales fell to 33,900 in the first quarter from 48,500 in the prior quarter and from 84,860 a year earlier, the latest report by the Hope Now alliance of mortgage servicers
shows.

The first-quarter decline comes after Congress failed to extend the Mortgage Forgiveness Debt Relief Act, which expired at the end of 2013.  Borrowers who complete a short sale this year could be taxed on any forgiven principal unless Congress passes an extension that is retroactive to Jan. 1.

"Some properties that may have avoided foreclosure as short sales are instead being foreclosed upon and contributing to the rise in REO stock," says Sam Khater, a senior economist at the analytics firm CoreLogic.

While foreclosure starts and home sales have been on the decline along with short sales, a report by CoreLogic shows the number of repossessed properties on the market has risen from 375,000 in August to 430,000 in March. This is due in part to lower investor demand for foreclosed properties but may also reflect Congress' failure to extend the Mortgage Forgiveness Debt Relief Act.

Senate Republicans are filibustering a tax-extender bill that contains a two-year extension to the debt relief act. The House is expected to delay any action on a tax extender bill until after the November elections.

Short sales generally considered less damaging than foreclosures because the former owner generally walks away with a few thousand dollars in pocket and a better credit score. The home is generally in better shape and commands a better selling price. Short sales peaked at 422,600 in 2012 and fell to 281,078 in 2013, Hope Now data show.