The MFDRA provides tax relief for mortgage debt forgiven on principal residences. Originally the MFDRA was set to expire at the end of 2009. Thanks to legislation enacted in 2008, however, MFDRA tax relief was extended through December 31, 2012. Unless the MFDRA is again extended, debt forgiveness after 2012 is taxable. Therein lies a malpractice risk for lawyers.
The essential provisions of the MFDRA, as explained in IRS publication IR-2008-17 (2/12/08), are:
Lawyers representing homeowner debtors in matters with MFDRA eligibility must get the matter completed by the end of 2012 for the client to qualify for the tax savings. Amounts forgiven after that date will be taxable unless exempted under some other law. Failure to meet the MFDRA deadline could lead to an expensive malpractice claim.
Conversely, lawyers representing lenders must consider the deadline to avoid making any misrepresentation to persons deeding in lieu of the foreclosure. The availability of the MFDRA tax break is an incentive that should help lender lawyers resolve foreclosures before the end of 2012.
Just as it is good risk management not to take a new matter with an imminent statute of limitations deadline, it is good risk management not to take a matter with MFDRA eligibility in the latter part of 2012 without carefully explaining to the client in writing signed by the client that due to time limitations it may not be possible to get the tax forgiveness. Additionally, lawyers not clear on the effect the MFDRA has on a client’s situation should consult a tax professional or the client's tax preparer. Then confirm the financial advice given in a letter following the consultation, with a copy to the client.
Source: IRS Publication 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals); TitleNews, American Land Title Association, July 2012, Ted Jones, “The Fuse is Burning and Time is of the Essence – The Pending Expiration of the Mortgage Forgiveness Debt Relief Act.”