Screwed twice

I've just been reading a post -- rather poorly written -- about a homeowner who bought his house a couple of years ago for $800,000 with a 100% mortgage. He now wants to buy the house across the street (which sounds as though it is similar to the house he lives in) for $500,000 and plans to walk away from the $800,000 house and hand the keys back to the bank.

There's a lot of babbling back and forth in the comments about the legality of this. Frankly, it doesn't strike me as illegal. That's what non-recourse mortgages are all about. The bank takes the risk that if the homeowner can't (or won't) make the payments, it gets the house. The bank charges for taking that risk by lending at a somewhat higher rate than it would have if the loan had been a recourse loan.

However, one line of argument in the comments thread did catch my eye. The forgiven debt is taxable income to the guy. And, how much is that? It shouldn't be the entire $800,000, but I can see the IRS arguing for that. You should at least be able to argue that whatever the bank got for the house was not forgiven. But, the problem here is that banks often get very little in these circumstances, since they seem to be institutionally incapable of selling houses at reasonable values. So, the guy could well end up having to pay taxes on $500,000 or so.

All of which raises an even more interesting question. All the folks who are actually going into default these days because they can't pay when the rates adjust may well end up owing huge tax bills because of the debt forgiveness they obtained.

Screwed twice! Once by the mortgage originator. Once by the government.