Thanks to the ever vigilant Arizona Mortgage Guru, we now know that the Mortgage Forgiveness Debt Relief Act has passed the US House. Next stop is the Senate, where I suspect it will pass and go on for signing by the President.
What is the Mortgage Forgiveness Debt Relief Act?
Currently, if part of your mortgage debt is "forgiven" via a short sale (selling your home for less than what you owe), the lender is required to send a 1099 income form in the amount of the forgiveness to our pals at the IRS, who then turn around and want you to pay taxes on that "income" — at your ordinary income rate.
The Mortgage Forgiveness Debt Relief Act will eliminate this nasty little side effect of a short sale. My understanding is it will only be available on your primary residence.
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rob aubrey 10.12.07 at 6:47 pm
It has been my understanding that it was already possible to get out of the tax of a debt relief. One of the stipulations is you need to be insolvent. Typically people that sell their primary residence in a short sale are insolvent.
Below is the form used and a response I found on a yahoo site.
IRS form 982 http://www.irs.gov/pub/irs-pdf/f982.pdf
The important consideration is your financial status at the time the debt is forgiven. You will need to compute your net worth at that time, or have declared bankruptcy.
If you are bankrupt, you are not subject to income tax on the cancelled debt.
If you are not bankrupt, you have to prove that you had negative net worth. You are not subject to income tax on cancelled debt up to the amount of your negative net worth. In other words, if your net worth is -$50K, up to $50K of cancelled debt is not subject to income tax.
Attach the documentation showing bankruptcy or insolvency to Form 982 to figure how much of the cancelled debt is not subject to tax.
Any amount of cancelled debt which is subject to tax goes on Line 21 Other Income of Form 1040.
Joanne Hanson 10.12.07 at 10:43 pm
Jay, one thing that hasn’t been mentioned is how these tax changes will be paid for. Although the details are not clear yet, according to The Square Feet blog, the plan is to close or tighten a loophole that allowed people to move into a vacation home property and have it become their personal residence, then sell after two years and pocket the gain on what had been an investment or second home. Sometimes the home was purchased using a 1031 exchange and had gains from other properties rolled into it.
Jay - The Phoenix Real Estate Guy 10.13.07 at 12:55 pm
Rob wrote: “Typically people that sell their primary residence in a short sale are insolvent.”
I’m not so sure about that Rob… I’m working with a couple of folks right now who got into some problems with ARM adjustments and some other issues and aren’t really insolvent.
But clearly many in this situation are, and I appreciate your pointing this out!
Joanne - interesting point that I hadn’t thought about. Will need to ponder that a bit!
Las Vegas Lawyer 10.17.07 at 10:34 am
Foreclosures will increase across the country due to people taking out loans that they can’t afford. When will it end? Is the government gearing to assist in the crisis? Should they stay out of it? Any thoughts?
Jay - The Phoenix Real Estate Guy 10.17.07 at 11:45 am
LVL - great questions! I have no idea when it will end. You’re asking the wrong guy about government intervention as I think the gov’t sticks their nose in *way* too many places already…
I do see the mainstream media reports that seem to imply every single “sub-prime” borrower out there is defaulting, or soon will. And that is simply not the case. Yes, foreclosures are up, and will probably go up for quite sometime. But the simple truth is, the vast majority of homeowners pay their mortgage and have absolutely nothing to worry about.
Blake 10.22.07 at 1:06 pm
You say “primary residence”.
So, i am reading this to mean that if i purchased a vacant lot of land for 250,000 (which i still owe), and it is currently worth 80,000 and my balloon payment is due at the beginning of the year. If I have to foreclose on the property — I would have to pay taxes on the 170,000?
Jay - The Phoenix Real Estate Guy 10.22.07 at 2:52 pm
Blake - I am *not* a tax specialist, accountant, etc. And it’s possible I have misinterpreted the pending legislation. It’s also possible the legislation could be changed/ammended prior to passing the Senate.
My understanding of the way the law is currently structured is that your secenario *might* be correct.
Even if this legislation doesn’t pass, or if it does and doesn’t cover your situation, there may be other ways for you to get tax relief.
My advice would be to consult a CPA familiar with the tax consequences of foreclosure. They need to be (and likely would be) up to speed on the possibilities of this current bill as well.
Rancho Santa Fe 12.27.07 at 12:21 pm
>If I have to foreclose on the property — I would have to pay taxes on the 170,000?
This law wouldn’t help you on vacant land. Not all foreclosures trigger tax bills though, depending on the state you are in, and whether or not you have a non recourse loan.
jennifer 02.14.08 at 2:24 pm
I owe $420,000 on my loan for my house that I bought in 2005. It’s current value is $260,000. Explain to me why I should continue paying on a house that isnt worth what I bought it for. It’s like throwing my hard earned money away in the trash!! So why shouldn’t I just walk a way and let it forclose?? The bank isnt going to say that they will somehow evaluate my loan and change the amount that I owe simply because my house is worth half for what I bought it for, correct??
The Phoenix Real Estate Guy 02.14.08 at 3:48 pm
Jennifer - What an awful position to be in. I have no good answer for you. Unfortunately there are never any guarantees in home values. Hopefully you weren’t mislead that there were. I don’t know where in the country you are located, but there is always the likelihood that values will begin to increase again. Of course I have no way to know if you are in a position to stick it out for the long haul.
I can’t tell you if you should walk away. How much you value your credit rating is a personal thing.
Will the lender change the amount you owe? Not likely by that much, but it sure can’t hurt to talk to them. They don’t want your home, believe me. There are other things they may be able to do to help mitigate the situation.