David Dayen: IRS Confirms that $12 Billion in “Mortgage Relief” in National Mortgage Settlement Completely Worthless

By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen

The IRS settles something I noticed a while ago and has now been finally confirmed. In short: big banks who robbed homes from Americans got a penalty that entailed, quite literally, giving homeowners worthless allowances.

The issue concerns the Mortgage Forgiveness Debt Relief Act, which expires at the end of the year. After December 31, all mortgage relief that involves debt forgiveness of any kind will be taxable to the borrower. This affects principal reductions, of course, but also short sales, with the idea being that this involves the bank “forgiving” the difference between the total owed on the mortgage and the price of the short sale. There are hardships exemptions to this but they involve the functional equivalent of bankruptcy – you have to prove that your total liabilities exceed your total assets.

Sen. Barbara Boxer wrote the IRS asking for a clarification about short sales in non-recourse states, like her home state of California. If a state is non-recourse, the bank cannot go after a foreclosed borrower post-foreclosure sale for a “deficiency judgment,” seeking money from that borrower if the sale price comes in lower than the price of the mortgage. This also has application for a short sale; technically speaking, in a non-recourse state the short sale is just a waiver of a deficiency judgment. So Boxer wanted to know whether Californians, in a non-recourse state, could still do short sales and not be subject to a tax on the debt relief, even if the Mortgage Forgiveness Debt Relief Act expires. Because, the theory goes, it’s not really a debt relief at all, since the bank cannot go after a California resident for the balance anyway.

The IRS replied to Boxer by affirming her theory:

Homeowners who live in states where mortgages are non-recourse—that is, where they aren’t personally liable for the unpaid balance—may avoid the potential tax hit even if Congress doesn’t act, according to a letter sent by the Internal Revenue Service released by Sen. Barbara Boxer (D., Calif.) on Friday […]

In the letter to Sen. Boxer, the IRS clarified that certain non-recourse debt forgiven by lenders wouldn’t typically be considered taxable income by the IRS. This means that for most California borrowers, the expiration of the tax provision may not have a meaningful effect […]

In the letter, the IRS wrote that “if a property owner cannot be held personally liable for the difference between the loan balance and the sales price, we would consider the obligation a non-recourse obligation.” As a result, the owner would not have to count that forgiven debt as income.

Here’s the letter to Boxer, which actually dates back to September but which I’m just hearing about now.

Here is why this is important, aside from Californians being spared from getting hit with a tax bill on a short sale. The Justice Department, in the National Mortgage Settlement, allowed short sales in non-recourse states to count toward the penalty the five biggest mortgage servicers “paid.” If the IRS says something is not a thing of value, it’s not a thing of value. The borrower would not be liable to make up the difference of the mortgage after a short sale anyway in a non-recourse state. The servicer didnt “forgive” anything. So the banks got away with paying off their penalty for a series of crimes with completely worthless non-recourse short sales. That’s the implication of the IRS letter.

Think this doesn’t matter? It’s not just applicable to California, but any non-recourse state. There are 12 of them, as I found out when I researched this situation over a year ago. And as of last August, as I wrote, the majority of short sales counted under the settlement were going to non-recourse states, where the servicers had no ability to recoup mortgage balances anyway:

What we’re saying in that instance is that banks are given credit for paying a “penalty” by not collecting the balance of a mortgage after the sale, something they are PROHIBITED BY THE STATE FROM DOING.

And guess what? The OMSO report breaks this down by state. So I can see that the five big banks participating in the settlement got credit for $522 million in short sales in Arizona and a whopping $3.9 BILLION in California. Those two alone equal over half of the total short sales in the report. If you total up all the non-recourse states (I’ve put their raw totals at the end of this piece), you get over $5 billion in short sales coming from states that bar banks from pursuing a deficiency judgment.

This is a handout to the banks. Some part of this $5 billion will satisfy their punishment in the settlement (not all of it; there are portions of a dollar in the formula based on where the loan was held in portfolio or was a securitized loan held by an investor). And it represents $5 billion these banks could never collect, $5 billion they’re barred by collecting by law. Banks should never have been allowed to count deficiency judgment waivers or short sale forgiveness in non-recourse states. But they are, and they’re doing it in big numbers.

That was as of last August. Here are the most recent numbers, through the end of June 2013, compiled by the Office of Mortgage Settlement Oversight. Over $12 BILLION in short sales went to non-recourse states, now described by the IRS as worthless for the borrower, because the bank is already prohibited by law from collecting any of the debt it “forgave” in those states. That’s out of a total of $20.9 billion in short sales counted in the settlement, so well over half came from non-recourse states. The breakdown here:

Alaska: $2,589,876
Arizona: $1,114,023,528
California: $9,464,156,773
Connecticut: $117,209,151
Idaho: $89,738,344
Minnesota: $162,181,513
North Carolina: $145,747,252
North Dakota: $1,190,321
Oregon: $208,572,946
Texas: $117,511,953
Utah: $154,708,217
Washington: $506,984,592
TOTAL: $12,084,614,476

In general, servicers got 45 cents on the dollar credit for short sales, though 20 cents on the dollar for short sales on investor-held loans and 100 cents on the dollar for extinguishing second liens in a short sale (see section D-1 here). Also the non-principal reduction credit was capped at $7 billion of the $17 billion. Without knowing everything about the loans it’s hard to know exactly how much credit banks got for worthless non-recourse short sales, but given that short sales are a healthy portion of the top-line, un-weighted consumer relief number that the Administration likes to throw about – here’s Obama using it just three months ago – We can safely say that over $12 billion of the $50 billion in “consumer relief” that was supposed to be a penalty for misconduct has been shown by the IRS to be totally worthless. That’s close to 1/4 of the total.

The entire mortgage settlement was a rotten scam, but we can say that unreservedly in the case of 25% of it.

POSTSCRIPT: I recognize that life is slightly better for a borrower after a short sale than after a foreclosure, with the main benefit being a slightly lesser hit to their credit report. But first, the mortgage settlement was allegedly designed to keep people in homes, not help them marginally with being kicked out. And in this case, I’m looking at the nature of the penalty for the banks, not the effect for the borrower. And clearly the penalty is worthless.

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About David Dayen

David is a contributing writer to Salon.com. He has been writing about politics since 2004. He spent three years writing for the FireDogLake News Desk; he’s also written for The New Republic, The American Prospect, The Guardian (UK), The Huffington Post, The Washington Monthly, Alternet, Democracy Journal and Pacific Standard, as well as multiple well-trafficked progressive blogs and websites. His has been a guest on MSNBC, CNN, Aljazeera, Russia Today, NPR, Pacifica Radio and Air America Radio. He has contributed to two anthology books, one about the Wisconsin labor uprising and another on the fight against the Stop Online Piracy Act in Congress. Prior to writing about politics he worked for two decades as a television producer and editor. You can follow him on Twitter at @ddayen.


  1. Synoia

    “the IRS clarified that certain non-recourse debt forgiven by lenders wouldn’t typically be considered taxable income by the IRS.”

    Maybe not, but the banks send the borowers a 1099 for the deficiency and then the borrower has to use the IRS insolvency test to avoid taxes on the “forgiven” part of the debt.

    The key phrase is “certain non-recourse debt”

    1. chicagogal

      Don’t think the banks do send 1099s for deficiency judgments. My final foreclosure docs show a zero dollar deficiency, but the bank never sent me anything for my taxes. I did look at the IRS requirement under the MFDRA early this year, but if I remember correctly, they don’t require it to be shown on the return or have any docs submitted.

      Question is, since Sen. Boxer now has proof that it was a worthless settlement point, is she going to do anything to force the banks to pony up actual relief?

  2. DakotabornKansan

    Language is a tool for concealing the truth.

    “Mortgage Relief,” – in which the banks got away with paying off their penalty for a series of crimes with completely worthless non-recourse short sales.

    “Giving ‘debt relief’ to people that really need it, that’s what foreclosure is. Homeowners are probably better off going somewhere else, because they get relieved almost 100 percent of the debt through foreclosure.” – Jamie Dimon, JPM Chase

    “As societies grow decadent, the language grows decadent, too. Words are used to disguise, not to illuminate, action: you liberate a city by destroying it. Words are to confuse, so that at election time people will solemnly vote against their own interests.” – Gore Vidal

    The American public is like a deaf spectator seated in the back row at a crowded sports stadium. They haven’t a clue what is happening, why it is happening, or what should happen.

    And so they move along in single file to the next shearing shed.

    1. Teejay

      I love that phrase. “Language is a tool for conceling the truth.” Chairman Alan Greenspan’s Congressional testimony, PR reps for corporations that have blown up the economy or the environment are among a long list that prove this.

  3. Pearl

    Hi David!

    We’re LUCKY! Apparently, we get a 1099(c)EVERY year, post-foreclosure!

    Ocwen sent to us (and to the IRS, of course) a 1099(c) in January of 2012 for a property foreclosed upon in January of 2011, and then Ocwen sent another 1099(c) in January of 2013 for the same property, but saying that the property was foreclosed upon in January of 2012.

    We’re going for the “Trifecta,” and we’re hoping they send to us another 1099(c) in January of 2014 for the foreclosure that they will then report to have taken place in January of 2013.

    We’re still waiting for Ocwen to do something kosher. Anything kosher. Anything at all. It hasn’t happened yet, but we’ll let you know if it ever does.


    By the way–are you noticing a lot of this on such properties on sites such as Zillow:

    09/26/2013 Listing removed $34,900 — $36
    08/02/2013 Pending sale $34,900 — $36
    07/30/2013 Listed for sale $34,900 — $36
    04/20/2011 Listing removed $34,900 — $36
    03/25/2011 Listed for sale $34,900 -53.5% $36
    01/04/2011 Sold $75,000 -31.8% $78

    (The 01/04/2011 “sale” being the “surprise” foreclosure.)

    Anyway, I notice it a lot now on foreclosed properties. The part that has me perplexed is the status change that takes the property from “pending” to “listing removed.” It’s as though they always want to have the property “removed” or “pending,” but not necessarily “sold?” Any ideas on that?

  4. Jim A

    A short sale is NOT a waiver of a deficiency judgment. In fact in some cases lenders have insisted that homedebtors reaffirm their debt with a promissary note. Rather it frees the PROPERTY from the lein upon it, which means that the new purchaser can get a new mortgage on it.

  5. Stupendous Man - Defender of Liberty, Foe of Tyranny

    Aw, crap!!

    I can already tell this isn’t gonna be a good week. Just last night I learned that ice cream cones are hollow. And now this.

    Aw, crap!!

  6. alex morfesis

    words and language thrown around as if it has no meaning

    short sales (historically) included a release of financial liability…but this new generation of zombie real estate agents have drunken the flavor aid(jim jones was too cheap for kool aid) and now suggest the world revolves around their commissions and a “short sale” now just means saving the lender the costs of dealing with a foreclosure and keeping the homeowner as a caretaker to insure the property shows better than would an empty home.

    and the term deed in lieu has legal meaning in many states, yet real estate agents are telling people and lawyers for banks in foreclosure cases (at least in florida) that deed in lieu does NOT mean release of liability…even though there is plenty of case law tied to the use of the term in Florida…

    sadly, the morgage settlement is going the way of the tobacco settlement as those of us who lamented feared at the outset…big press conferences and after the dust settles…the money gets pocketed to handle budget problems(or technically ‘borrowed against’…but same net effect…poof goes the money)

    and the notion that a short sale is “better” for your credit score is some fantasy put out by the same real estate agents trying to force you to give in to their need to lick the boots of the bankers to get the opportunities/leads for listings…

    the IRS gets these 1099s electronically and does not review them. The parties sending them most of the time are not even the right party…

    there used to be a form the IRS had to allow you to fight a 1099 as for many years psycho christian republic Koch brother tea party CAPITAL LETTERS OF YOUR NAME luddites would send out phony 1099s against people they had no connection to or bureaucrats who they were pissed off at…but my conversations with the office in Pennsylvania on the issues seems to have suggested the bankers made sure that form disappeared.

    This whole mess was not some oops…there was money to be made skimming pensions by having your local government enterprise take bribes(pay to play prosecutions) and then turn a blind eye to what was being signed. There is a Citibank report from 2002 about making money from a crash and the things that would have to come together to make that a reality…

    Fannie and Freddie, we are told, had losing derivative positions over that wonderous weekend in September, about one year after BNP Paribas froze up markets by its August 7 actions in 2007. But has anyone actually been shown the losing positions…all the noise all the smoke and mirrors…by now, should we not have seen a nice GAO report on these purported losses…

    The big noise was that interest rates were going to have to go back up on these “teaser” loans…but what if these “teaser” loans were not teaser rates…what if the american borrower has been getting raped for the last decade when the throughput rate for home loans was at 200 basis points in most of the other OECD countries…its bad enough the american public have to have a deficit so that the global banking system can have AAA rated Basel compliant capital, but why must the average american pay three times what the average japanese home owner pays

    “Sumitomo Mitsui Trust Bank has been offering a floating rate of 0.775 percent since December 2010 for most qualified borrowers”

    from the same global pool of funds…

    we been tooken…

    1. Jim A

      I think that it’s important to realize that before the great RE bubble and bust, people who were foreclosed on, got a short sale approval, or offered their deed-in-lieu rarely had enough assets to be worth sueing. If there was any anticipation that there were, than the banks would have charged noticeably different rates in recourse vs non-recourse states. The tax advantage of being able to declare those as “bad debt” was worth more to the lender than they any returns they might have anticipated in trying to get a notice of deficiency or selling that debt to debt collectors.

      But with the bust, there was an increase in the number of “specuvestors” like Casey Serin, and lenders didn’t want to be the one left holding the bag if there was any money to be wrung out of borrowers. But more importantly IMHO, there were vastly fewer “old hands” with actual experience in servicing and loss mitigation. The few people around who were actually making decisions had simply never internalized the “it’s just not worth it,” idea behind forgiveness of mortgage debt in default*. The fact that actually recognizing that all that money was NEVER going to be paid would often result in the insolvency of the lenders added to the “Let’s take a chance at trying to recover some of this.”

      *really no reason to distinguish between Short sales, foreclosures or DiLs they all represent borrowers not performing according to their payment terms.

    1. Pearl

      Yes, I noticed that, too!

      So, David, did you submit a Haiku to Matt Taibbi for his free Jamie Dimon t-shirt contest? (Contest ends today!)

      I’ll show you mine if you show me yours…..


  7. Linden

    The first loans the lenders “forgave” under the settlement were loans that were already being wiped out in Chapter 13 bankruptcies. Bankruptcy lawyers saw a wave of forgiveness letters come to their debtors last year, particularly from B of A.

  8. Diogenes

    Arizona is not a non-recourse state.

    It is a recourse state with an anti-deficiency statute, in the event of foreclosure ONLY, on a single family home on 2.5 acres or less.

    There is no anti-deficiency protection on a short sale.

  9. Diogenes

    And having gone through the foreclosure process in AZ in 2010, I wish to add that there was no “significant” downturn in my credit.

    Creditors seemed to distinguish between a strategic default and one due to financial problems. We stayed current on ALL other accounts and even the bank that originated the loan (which it later sold to Freddie Mac)did not cancel my unsecured credit card with them. After selling the loan to Freddie Mac, the lender stayed on as the servicer, and they were very laissez-faire when I told them we were doing a strategic default.

    Today, my credit is back in the 730-750 range, depending on reporting agency.

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