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In San Diego’s hemorrhaging real estate industry, it’s better to be upside-down and rich than upside-down and poor. That may sound axiomatic — it’s always nicer to be rich than poor — but carriage-trade folks whose homes are underwater can work the system more easily than poor folks in the same sorry situation.

The key is the short sale, in which a lender agrees to discount a loan balance when a house is upside-down — that is, the home is worth less than the balance on the mortgage. In a short sale, the homeowner sells the asset for less than the outstanding balance of the mortgage on the property, and the bank is willing to accept the lower figure, often to avoid the expense and hassle of foreclosing and dumping the property on a glutted market.

A short sale can be a good deal for the seller because, generally speaking, one’s credit record is less damaged from a short sale than a foreclosure.

I checked HouseRebate.com for information on short sale and foreclosure homes that are currently for sale. I got information on average single-family home prices from DQNews.com. Generally, there are more short sales and foreclosures in the poorer areas than the richer ones. For example, in Encanto, there are 101 foreclosures and 191 short sales on the market. In the 92067 zip code of Rancho Santa Fe, there are zero foreclosures and 7 short sales. The ratio of short sales to foreclosures is higher in the affluent areas. On a relative basis, wealthier people are taking advantage of short sales more than poor and moderate-income people are.

On the surface, this would seem to be an anomaly. “Banks check out clients to be sure they need a short sale,” says John Smith of Old Mission Mortgage. “They are not going to let Donald Trump do a short sale. They do due diligence on the client. Possibly we [have had] some very unqualified borrowers in some big homes — people buying on speculation that they could flip [sell] the house in a year.” These flippers may or may not qualify for a short sale.

Here are some examples: listed are the name of the market, the median price of a single-family home there, and the ratio of short sales to foreclosures. Coronado, $1.3 million, 5 to 1; La Jolla, $1.8 million, 5.6 to 1; Scripps Ranch, $620,000, 4.4 to 1; Tierrasanta, $499,000, 9.3 to 1; Del Mar, $1.5 million, 2.8 to 1; and Carmel Valley, $865,000, 9 to 1.

By contrast, here are prices and ratios from representative lower-scale areas: National City, $212,000, 1.8 to 1; City Heights, $221,000, 2.25 to 1; Encanto, $245,000, 1.9 to 1; Logan Heights, $147,000, 2 to 1; Golden Hill, $178,000, 2.5 to 1; Paradise Hills, $260,000, 2.4 to 1; and Lemon Grove, $263,000, 2.1 to 1.

So why do the poorer people less often take advantage of the short sale? “Look at the socioeconomic base,” says Brian Yui, whose company runs the HouseRebate.com website. “People haven’t been informed about the short sale process.” Also, the foreclosure proceeding has its advantages. The family lives in the house for three or four months essentially rent-free. Then, before seizing the property, the bank pays the household $500 to $1000 to move out.

Banks take a long time to approve a short sale. “Most real estate agents steer away from short sales,” says Smith of Old Mission. “Banks are so hard to work with. However, agents get a bigger payday on a $1.5 million property than a $250,000 one.” So there is less aversion to a short sale in the upscale areas.

The affluent “have time to make a short sale,” says Sharon Hanley, market analyst for Oceanside’s New Housing Monitor. “They realize they are upside-down. Why sit here with a million-dollar loan when their house is worth $700,000? They are in a position where they can continue to make the payments” until the bank approves the deal. The opposite is true with people in poorer markets. “They were put into these crazy loans where payments are doubling and tripling.” There is urgency. Foreclosure is the easier route, and they can’t afford to worry about their credit rating.

Those blessed with prosperity “have more access to real estate attorneys or have better lender relationships,” says Peter Reeb, president of Reeb Development Consulting. “They are better able to negotiate on their own behalf.” The home may be the third or fourth or fifth they have bought through the years. “These people know how to better protect their assets, minimize losses,” while protecting their credit rating.

Agrees Peter Q. Davis, retired San Diego banker, “I would think…that those with higher home prices may have a better understanding of the tools available to them and a stronger desire to protect their credit ratings. A lot of times the high-end folks deal with friends or associates for their loans, and this could also affect their actions.”

“One reason short sales are more successful in upscale areas is that demand is higher,” says Stan Sexton of La Mesa’s New Horizons Realty. Sophisticated buyers “can afford a more expensive home and get 30 to 40 percent off.” Both buyers and sellers “are very sophisticated people with higher incomes; they know how to play the short sale game. People at the lower end are very strapped, unemployed or underemployed. Mexicans are leaving California for Mexico. They can’t get jobs here.”

Short sales can be complicated — one reason it takes banks so long to approve them. Sexton has one client with a $1.06 million mortgage. There is one offer on the property for $790,000, one for $810,000 and two for $800,000. But the bank is holding up the deal; there is a second mortgage on the property that must be unraveled. Sexton was showing property in EastLake on which the loan is $1.2 million and the bid is $639,000. “Can you imagine the amount of money these banks are eating in short sales? And they usually lose even more on a foreclosure.”

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Comments

Fred Williams Oct. 9, 2008 @ 8:19 a.m.

Don, you know we got here from hubris.

The Hubris of bright young math prodigies given a long leash in cooking up new financial flights of fancy.

The Hubris of the executives who invested in these flights of fancy, not even pretending to understand their underlying value.

The Hubris of government support and encouragement toward making bad loans to unqualified buyers over the last thirty years. In the last decade, this accelerated as a direct result of politicians currying favor and touting home ownership as the American dream.

Unfortunately, we know that Hubris is always followed by Nemesis.

Nemesis is a bad-mo-fo when it comes time for exacting his due.

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Don Bauder Oct. 9, 2008 @ 10:16 a.m.

Response to posts #3: Once again, Fred, you have shown your grasp of the peril before us, and you have expressed it quite well. Best, Don Bauder

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mhpapc_controller Oct. 9, 2008 @ 11:32 a.m.

In response to JohnnyVegas:

The tax consequences of a short sale may only affect speculators and not those parties which made the property their primary residence. The IRS has information about this which can be accessed at http://www.irs.gov/.

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JohnnyVegas Oct. 8, 2008 @ 5:42 p.m.

The banks are the road blocks on short sales.

I personally have had numerous associates involved in short sales the last 12 months and not a single one went through-they all blew up because of bank in action.

Also, any amount written off in a short sale becomes TAXIBLE INCOME for tax/IRS purposes. Another BIG road block.

Banks employee some of the stupidest people around in their real estate departments. If they were smart they would contract out all real estate matters to outside brokers.

Real etsate is too big a ticket item to screw up on. It is not rocket science but it does require a certain degree of sophistication (more so in income stream investments like shopping centers/office buldings/industrial buildings).

Reminds me of a deal I did at the end of the last real estate downturn in 1998 on a SFR that was owned by Freddie Mac. The place had been on the market 8 months with numerous deals falling apart from unqualified buyers when I made a very fair and doable offer. Then Freddie tried to nichol and dime me over a lousy $2 grand and I got bent and told them to pound sand. The home sat vacant another 3 months when I made a second offer-15% BELOW the first 3 months earlier. That deal went through-they learned their lesson the hard way-losing 15% plus 3 months carrying costs of at least 2-4%.

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Don Bauder Oct. 8, 2008 @ 7:15 p.m.

Response to post #1: There are complications, such as multiple mortgages on some properties, but there is no question that some bankers are slow on the learning curve. The proof is in an even bigger pudding: how in the world did they end up with so many worthless derivatives? Many banks -- including the biggest -- are technically insolvent. The government doesn't want us to know that. Best, Don Bauder

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inactive Oct. 9, 2008 @ 10:55 p.m.

According to the WSJ, the govt will probably announce that they will back all bank deposits. But I think the problem lies more with interbank lending;unlesss they are also guaranteeing bank debt it appears everyone will still afraid to lend so credit is still almost non existant. I would characterize much of this as panic selling. The losses weren't confined to financials. The losses were in every sector across the board. Even IBM finished more than 6% off the daily high after their earnings announcement, which is completely ridiculous. People apparently would rather dump their stocks for cash and toss it into an account earning literally no yield than risk it in the market. Alot of the so called "experts" are saying there is a 1000 point rally out there signaling we have hit bottom. It's possible there could be a small rally tomorrow in anticipation of some kind of announcement this weekend from the G7 meeting or the IMF. More likely, selloffs will continue. I would not be supprised to see the DOW drop to a 7500-7800 floor sometime next week before it tries to stage a stong rally. Something to remember. Historically, October is the Dow's best month and the 4th quarter is the best quarter. The way this month has started, that seems a tall order with almost a 25% loss in the last 8 trading days. This next week promises to be one of the most intersting in my lifetime anyway.

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Don Bauder Oct. 10, 2008 @ 7:10 a.m.

Response to post #17: Yes, somewhere there is a 1,000 point rally out there. But what is the launching pad? It's probably time to buy superb consumer staples stocks such as P&G and J&J, which have good dividends that should be well covered. Incidentally, I question that October is a good month for the Dow, although if you can prove from the Trader's Almanac that I am wrong, I will humbly bow to your expertise. Certainly, November and December are very good months for the market. Best, Don Bauder

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inactive Oct. 10, 2008 @ 8:31 a.m.

Responce to # 19: I misquoted myself after misreading my notes. I believe I meant to say October is the start of the historcaly best quarter, the 4th quarter.And the way this month has started, that seems a tall order with almost a 25% loss in the last 8 trading days. This comes right on the heels of historicaly worst month of September. I still think the Dow has a hard landing of 7500-7800 at close before we see an actual capitulation and things begin to recover for real, albeit very slowly after maybe one big rally day. When my grandfather died, he left me a small inheritance, with I was able to have either at age 25( I think I was 14 at the time) or when I graduated from college. I waited until I got out of grad school then took the money and invested it over the next couple of years.With some very, very good advice, I bought 50-100 shares of about a dozen or so companies. PG happens to be one of them. KO, and WMT are a couple of others. Thank god I never bought any financials. I'm concerned about the losses the market has suffered. But since my intention from way back when was not to touch the stock until age 59 1/2, I'm not panicking......not yet anyway. I still have over 8 yrs to make up the loss. But if the Dow should keep going down past 7000,that may change.

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JohnnyVegas Oct. 9, 2008 @ 1:26 p.m.

If the IRS is not taxing the forgiven loan debt as income, including those that used the property as a primary residence, then the IRS have changed their rules.

I have not heard that-I will admit I am not up to speed on the RE brokerage business today though.

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Don Bauder Oct. 9, 2008 @ 2:28 p.m.

Response to post #5: Congress made a recent change in this. Best, Don Bauder

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Don Bauder Oct. 9, 2008 @ 2:30 p.m.

Response to post #6: But you are up to speed on the stock market, Johnny. You said the Dow would be below 9,000 at Friday's close. It closed well before 9,000 today (Thurs. Oct. 9). Did you have remunerative short positions? Congratulations. Best, Don Bauder

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a2zresource Oct. 9, 2008 @ 3:39 p.m.

Regarding #2 and bank insolvency:

Today's DJIA selloff sems to have come after CNBC had discussion of the adequacy of the FDIC chairman's troubled bank list... until that discussion, things didn't seem that bad.

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inactive Oct. 9, 2008 @ 5:14 p.m.

GM's 30%+ fall also had a great deal to do with the plunge also as they are 1 of the stocks that make up the Dow. I saw the market begin to fall in the last hour after it was announced that S&P put GM on credit watch negative. Also there was a noticeable groan on the floor when the Dow fell under the 9000 mark. Right now negative psychology is playing a role and that psychology is PANIC.

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JohnnyVegas Oct. 9, 2008 @ 6:08 p.m.

I am now worried that the DJIA could fall below 8K, and if that happens our goose is cooked.

Panic could cause huge sell offs from every direction.

I am actually fairly worried at the moment.

I think the $700+ Billion bailout is really starting to look stupid now that the market has dropped 25% in 10 days. I hope we have a big day tomorrow and things even out.

Hard to predict how this one works itself out-we are in uncharted waters now.

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Don Bauder Oct. 10, 2008 @ 7:13 a.m.

Response to post #17: Seconds ago, the Dow was back in positive territory -- what a rollercoaster! Smacks of manipulation via options and futures, but I haven't been paying close attention this morning. Best, Don Bauder

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Ponzi Oct. 9, 2008 @ 6:59 p.m.

Now countries are biting it. Iceland is broke. We can up the game from guessing which bank will fail to which country will fail now.

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Don Bauder Oct. 9, 2008 @ 8:56 p.m.

Response to post #9: It's possible that discussion moved the market. Best, Don Bauder

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Don Bauder Oct. 9, 2008 @ 8:58 p.m.

Response to post #10: S&P's action on GM was definitely a market mover. It particularly moved the Dow. Best, Don Bauder

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Don Bauder Oct. 9, 2008 @ 9:02 p.m.

Response to post #11: If we have a large percentage of major banks under water -- and I am becoming more persuaded that we have -- then the selloff might not be a panic. The word "panic" connotes an emotional reaction. A selloff as a result of well-grounded suspicions about bank safety would be based more on hard analysis of the consequences than on emotion. Best, Don Bauder

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Don Bauder Oct. 9, 2008 @ 9:04 p.m.

Response to post #12: Once countries start going under, it won't be long before states and municipalities go the same route at a rapid pace. Best, Don Bauder

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inactive Oct. 10, 2008 @ 6:49 a.m.

11

The dow fell below 8000 6 minutes into today's session. Two minutes later it was in the 7800's. Right away I ran outside and looked up and saw...............that the sky was not falling. Five minutes later it was back up to 8400. Panic is the cause for the selloffs in the last week or so. No one is paying attention to the fundamentals. You can either hang on and ride it out or sell, sell, sell and run for your life. With this amount of market volatility who can say. Let's see how it plays out.

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Don Bauder Oct. 10, 2008 @ 9:07 a.m.

Response to post #19: The 1929 crash came in October; ditto the 1987 crash, etc. I think it is the second worst month, historically, to September. PG and KO are good stocks to own. Just ask Warren Buffett. Best, Don Bauder

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inactive Oct. 10, 2008 @ 11:48 a.m.

response to #22: Actually, over the last 100 years, October has finished with an average .15% gain for the month. Don't forget that even after the 22+ % loss on black monday, the Dow recovered to finish the year with about a 2 1/4 percent gain . I think the Dow closed @ about 13,200 on December 31st, so I think 5000 + in the next 11 weeks or so is not going to happen. November,December and January have the best 3 consecutive gain averages so maybe the light at the end of the tunnel is the train on the other track, not the one we're on. I'd like to say I gave Warren really good advice, but in reality I have had great advisors. Twenty five years ago I was told if I stuck with companies that either made products consumers would need or sold the products consumers needed, over the long period they would do fine. Obviously I oversimplified, by you get the idea. Like I said, the next week or so is going to be very interesting indeed.

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Don Bauder Oct. 10, 2008 @ 1:45 p.m.

Respose to post #23: Yes, buy companies that have big market shares in products that people must have -- consumer staples. P&G, J&J are best examples. Best, Don Bauder

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Burwell Oct. 10, 2008 @ 11:22 p.m.

Forgiven loan debt on a primary residence is generally not taxable in a short sale. The debtor does not recognize taxable debt relief income unless the debtor is rendered solvent by the debt discharge. And the amount of taxable debt relief income is limited to the extent the debtor is solvent after the discharge. If a debtor stiffs the bank for $200,000 in foreclosure and after the $200,000 debt discharge the debtor has a $10,000 net worth (assets minus liabilities), the debtor's taxable debt relief income is limited to only $10,000. Most debtors are insolvent after the discharge. The debt relief rules for commercial and rental properties are far more generous and most property owners are insulated from debt relief income.

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Don Bauder Oct. 11, 2008 @ 8:15 a.m.

Response to post #25: Maybe you can explain the law change, and when it took place. Best, Don Bauder

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Burwell Oct. 11, 2008 @ 9:31 a.m.

The tax law change does not help debtors who walk away from their homes and mail the keys back to the bank. Debtors in this situation must recognize debt relief income unless they meet the insolvency exception. Debtors also have several other ways to dodge taxes on debt relief income but most are able to qualify for the insolvency exception. The tax law change applies to debtors who receive loan modifications (for example a permanent reduction in loan principal balance) that enable them to remain in their primary residences and continue making mortgage payments. Debt forgiveness in this situation is not taxable to the debtor. The tax law change does not apply to owners of commerical and rental properties.

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Burwell Oct. 11, 2008 @ 9:34 a.m.

The law change applies to debt forgiven in 2007, 2008 or 2009.

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Burwell Oct. 11, 2008 @ 10 a.m.

My comments in Post #25 apply to years before 2007. My comments in Post #27 are not correct. The law changes apply to foreclosures as well as loan modifications in 2007, 2008, and 2009.

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Don Bauder Oct. 11, 2008 @ 12:23 p.m.

Responses to posts nos. 27-29: I think everybody would be well served if you summed up the situation in one post: what taxes would be paid today by debtors in what situations? Use the current law as your framework. Many thanks, Don Bauder

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JohnnyVegas Oct. 11, 2008 @ 12:36 p.m.

Hmm.... it apears a 2007 law chnaged all the rules.

I am positive at one time any debt discharged on a short sale was taxible income. I don't know if the 2007 law changed that or one even before it, but that used to be the rule.

It is a needed change;

Lots of questions have arisen from people since President Bush signed into law the Mortgage Forgiveness Debt Relief Act of 2007, whereby in certain circumstances, a homeowner does not have to pay federal income tax on debt forgiven on a loan secured by a qualified principal residence via a short sale, foreclosure, deed in lieu, loan workout or short refinance where the loan amount was reduced and forgiven in order for the homeowner to keep the property.

http://www.homesalessandiego.com/blog/mortgage-debt-forgiveness-law/

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MsGrant Oct. 11, 2008 @ 1:36 p.m.

That was the law for years, #31. Debt relief was indeed a taxable incident. Because lenders wrote off the loss as a credit to them, there needed to be a corresponding debit on the homeowner's part to offset it. IRS rules. Who knows what applies now. It seems to change daily. Bottom line though is that if you are not making your mortgage payments, chances are you will not pay your taxes either. I've also heard that some lenders are not 1099 homeowners for fear of bad faith claims.

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Burwell Oct. 11, 2008 @ 3:35 p.m.

If (1) you lose your principal residence to foreclosure, (2) sell your residence in a short sale, or (3) the lender agrees to reduce the amount of your loan so you can make the payments, you will likely realize Cancellation of Debt (COD) income. Prior to 2007 you could avoid paying taxes on COD income merely by demonstrating that you were insolvent after the debt was discharged. If you were solvent after the debt discharge, COD income would be taxed only to the extent you were solvent after the discharge. In 2007, 2008, and 2009 the first $2 million of COD income related to debt on a principal residence is tax-free regardless of whether you are solvent or insolvent after the discharge. The new rules apply only to debt that is both (1) secured by the personal residence, and (2) used to purchase or improve the personal residence. You’re out of luck if you used a HELOC to buy cars, boats, go on vacation, pay college costs, etc. Under the new rules discharge of HELOC debt that wasn’t used to improve the principal residence still triggers taxable COD income unless you can meet the insolvency exception. Homeowners facing foreclosure, particularly when HELOC debt is involved, should get professional tax help before they decide what to do.

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Burwell Oct. 11, 2008 @ 3:50 p.m.

Response to #32, under the old rules most debtors were able to avoid debt relief income under the insolvency exception. The old and new debt relief rules are explained in detail below.

http://www.nysscpa.org/cpajournal/2008/408/essentials/p44.ht

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Don Bauder Oct. 11, 2008 @ 9:34 p.m.

Response to posts #31 through 35: It seems that this is settled. Thanks to all for the research. Best, Don Bauder

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Don Bauder Oct. 12, 2008 @ 6:45 a.m.

Response to posts #37 and #38: Yes, HELOC is an acronym for home equity line of credit. HELOC used to be ubiquitous. No longer. Best, Don Bauder

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justinknowstierrasanta Aug. 14, 2010 @ 3:13 p.m.

It is very interesting looking back at these comments and how the Real Estate Industry has shifted paths on Short Sales and Foreclosures. The problems with Short Sales still loom on the horizon, and it will take forever to clear them. Yes foreclosures are down at the moment, but who knows for how long...and if there is a shift in government in the fall...and regulations are lifted on the banks...who knows what will happen then? NO ONE.

A few thigns are for sure....time for short sales has gone down. Exceptions to deficencies have grown, HAMP was a joke....the few people that qualify for HAFA have it pretty good, and though prices aren't dropping in conforming and jumbo conforming markets, they're not going to get underwater borrowers out for years to come (another 10 according to Case-Shiller.)

I updated some Short Sale FAQs recently if anyone is passing by this post:

http://www.justinknowstierrasanta.com/ShortSaleInfo.ubr

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SteveFromBoston Aug. 20, 2010 @ 5:29 a.m.

On taxes: See section 108 of the Internal Revenue Code and the Mortgage Forgiveness Debt Relief Act. If the lender forgives debt, the homeowner will receive a 1099C for the amount forgiven. On a primary residence, the taxpayer can get up to $500,000 in relief from that 1099C (filing joint return - half of that if filing single). It can be claimed as a primary residence if the individual lived there 2 out of the last 5 years if memory serves me correctly.

Where people get into trouble is: The rules state that the income can be absolved only on that portion of the debt forgiveness that is "directly related to the decline in value" of the property. So if you refinanced your mortgage, or you took out a line of equity (HELOC)and you paid for your kid's college education with it, or bought yourself that Lexus you always wanted, those funds have nothing to do with the decline in value of your property and are taxable.

That aside, most homeowners would have little trouble getting relief from the 1099C and should seek the advice of a competent tax adviser/CPA. You can be forgiven more than $500,000 if you can also be declared insolvent (negative net worth). I think the limit is $2M if you're insolvent.

If it is not your primary residence, the Mortgage Forgiveness Debt Relief Act does not apply, and you have to rely solely on the insolvency rule.

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