It’s important to remind everyone that the Mortgage Forgiveness Debt Relief Act of 2007 was extended through 2012. If you’re thinking that you may let your home go to foreclosure think again because completing a short sale may be a better option.
Originally introduced to protect homeowners who are struggling in today’s troubled housing market by providing tax relief for homeowners who had part of their debt forgiven as a result of cancellation-of-debt (COD). Essentially this bill provides debt relief for homeowners struggling with underwater mortgages or are otherwise having a hard time keeping up with their debt obligations.
Tax Implications of Debt Relief
Enacted in 2007 in Congress, the Mortgage Forgiveness Debt Relief Act was introduced to reduce the tax liability for homeowners who benefited from debt reduction in the form of loan restructuring, short sales or even foreclosure.
Prior to the passing of this Act any debt forgiven or canceled in this way was considered taxable income. Debt reduction had to be reported by both the lender and the borrower in their respective tax forms – Form 1099-C, Cancellation of Debt for the lender and Form 1040, Line 21 as other income for the borrower. Any amount forgiven would be recognized as taxable revenue by the IRS. The homeowner, in effect, would still have an obligation to the Government on assets he or she no longer possesses.
The Mortgage Forgiveness Debt Relief Act enacted in 2007 as well as subsequent state wide initiatives aim to give underwater homeowners a ‘tax holiday’ on any cancellation-of-debt (COD) income earned as a result of debt forgiveness.
A very basic example of this would be if a taxpayer defaulted on a $10,000 loan after paying back $2,000. The lender is unable to collect the remaining debt and cancels the remaining obligation of $8,000. Normally this $8,000 would be classified as taxable income, but thanks to MFDRA of 2007 the borrower’s tax obligations on this amount would be forgiven.
Of course it is a lot more complicated in reality – The amount of forgiven mortgage debt allowed to be excluded from income tax is limited to $2 million per year. The majority of people will fall under this amount.
The various Federal and State debt obligation reduction schemes can be a confusing and baffling topic for homeowners. Good hearted legislation designed to help homeowners mired in debt can be lost in a sea of confusing legalese. If your thinking of a real estate short sale in San Diego please give us a call. In addition make sure you talk to your tax preparer and/ or a real estate attorney. Every situation is a bit different but it’s important to know what all of your options are.