The End of Mortgage Debt Forgiveness?

The good news in the housing market is that foreclosure starts are at a 95-month low, according to RealtyTrac, the nation’s leading collector and aggregator of foreclosure data.

The bad news, at least for distressed homeowners who will need to short sell, obtain a principle reduction, or foreclose, is that the House of Representatives adjourned last week for the winter break without taking up a possible extension of the Mortgage Forgiveness Debt Relief Act of 2007.

What this means for distressed homeowners is that, as of Jan. 1, 2014, any home loan debt that is forgiven will be considered ordinary income, and homeowners will have to pay income tax on it.

History of Mortgage Debt Relief

On Dec. 20, 2007, President George W. Bush signed into law H.R. 3648, The Mortgage Forgiveness Debt Relief Act of 2007. The president described the act as something meant to “help homeowners who are struggling with rising mortgage payments,” by protecting them from higher taxes.

The act originally protected homeowners from taxes on debt forgiven in 2007 through 2009. The act was extended through 2012 with the Emergency Economic Stabilization Act of 2008, signed during the global financial crisis. Finally, the American Taxpayer Relief Act of 2012 further extended tax debt relief through the end of 2013.

Implications for Struggling Homeowners

“A typical homeowner who sells a house for $100,000 but still has a $200,000 mortgage could face a tax bill of $28,000” on top of any taxes already owed on their income, according to Mary Shandklin of the Orlando Sentinel.

Ironically, the expiration of the act comes at a time when lender programs to assist homeowners are proliferating. Homeowners may find it easier now to get mortgage debt relief, but at what cost? “They’d get debt relief on one hand, and a tax bill in the other,” says Marketplace’s Kate Davidson.

The California Exception

California homeowners – at least those considering a short sale – can breathe a sigh of relief. The IRS has agreed with California law that short sale debt that is forgiven is nonrecourse debt, and “thus does not create so-called “cancellation of debt” income to the underwater home seller for federal income tax purposes,” according to Rose Meily of the San Jose Mercury News.

How it Works

The IRS offers Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals), which clarifies how this debt is treated in regard to the homeowner’s income tax.

If you are given relief from your mortgage debt, your lender is required to send you IRS form 1099-C, Cancellation of Debt. The amount forgiven will be listed in box 2. This is the amount you’ll use for calculations on IRS Form 982. Consult with your tax advisor for answers to any questions you may have on the process.

Chances are good that when you could no longer make your house payments, you were insolvent. If you can prove to the IRS that your debts amounted to more than your assets at the time the debt was written off, you might not be taxed on the amount forgiven. Again, seek the advice of your tax advisor.

If you are one of the nearly 10 million Americans who are upside down on their mortgages, there is still hope. Some experts, such as Boston Community Capital’s CEO Elyse Cherry, believe that Congress will extend the act when they return early next year. If so, it will most likely have a Jan. 1 retroactive date.

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HelpUSell Properties is a website based on real estate services providing articles and resources in different topics such as 2nd mortgage, property for sale, appraisal, refinance mortgage rates, foreclosure, housing market, bad credit, and more for home owners and future home owners.

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