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Tax Consequences And The Home Affordable Foreclosure Alternatives Program

August 11th

More than a year after the US federal government introduced the Home Affordable Foreclosure Alternatives program, known as HAFA, there is still considerable debate as to its effectiveness. The program was designed to help streamline the short sale process by offering a short sale option to homeowners who do not qualify for a traditional loan modification.

According to the Government Accountability Office, HAFA disbursed just $9.5 million of an allotted $4.1 billion between April 2010 and December 2010. Through May of 2011 only 8,541 short sales were completed across the entire United States through HAFA.

Most banks will require that their customers ensure they do not qualify for home loan modification assistance before permitting them to pursue HAFA options. Bank of America reported in May 2011 that since the start of the program they have started 2,524 HAFA agreements and completed only 1,630

Many of these figures may be due, in part, to the consequences that can result from the use of such a plan as a means of foreclosure prevention. Given HAFA’s considerable potential for damaging a homeowner’s future tax payments, many choose to investigate other alternatives before considering the program.

Tax Consequences

It is important for homeowners to remember that, in terms of a decrease in a homeowner’s FICO credit score, short sales or deed in lieu of foreclosure programs such as those available through HAFA could still cause damage.

In fact, HAFA and other short sales can actually have extremely negative legal and tax penalties. For those selling a primary residence as a short sale, the Mortgage Debt Relief Act of 2007 typically allows taxpayers to exclude income from the discharge of debt associated with the sale.

The exclusion does not, however, apply if the discharge of debt is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial situation. It also will not apply if the sale involves any property besides a primary residence. In these cases, the cancellation of debt income will, therefore, be taxable by the IRS.

Homeowners should therefore think carefully before pursuing this course of action. It is advisable to exhaust all other possible means of foreclosure prevention first.


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