My Google Alerts have begun lighting up as reports are coming in that the Senate has approved the Mortgage Cancellation Relief Act of 2007.

This would relieve homeowners of the tax liability incurred on “forgiven” mortgage debt.

Currently IRS Code 108 classifies forgiven mortgage debt as “imputed income”, meaning the homeowner is required to pay taxes at their ordinary income rate on forgiven mortgage debt.

This usually rear its ugly head in short sale situations. An example is the best way to explain:

Say Joe Homeowner owes $300,000 on his mortgage. His lender approves a “short sale” that will net the lender $250,000. But Joe owes $300,000. The lender “forgives” this $50,000, but is required to report that to the IRS. Our buddies at the IRS then say, “Hey Joe, you owe taxes on that $50K, pay up!”.

Depending on Joe’s tax bracket, the taxes owed on that $50,000 in forgiven debt could run into the thousands (potentially many thousands).

This Mortgage Cancellation Relief Act would end that tax liability. According to reports, it also extends the deductibility of mortgage insurance premiums for three more years.

The National Association of Home Builders reports the debt forgiveness limit is $2 million and applies only to principal residences (in other words, those with investment/rental homes and second homes need not apply).

The Center for Tax Studies also adds this:

In addition to tax relief for debt forgiveness and mortgage insurance payments, the bill includes: tax relief for volunteer firefighters and emergency medical technicians; protection of tax relief for homeowners after the death of a spouse; and flexibility to help co-op tenant/owners deduct real estate taxes and mortgage insurance. The bill is fully offset by increased penalties for failure to file S corporation or partnership returns and new requirements corporate estimated tax payments. It is now necessary for the House to pass the updated legislation and send it to the president for signature. (added emphasis. Everthing I’ve read indicates the President will sign).

I need to read up a little more on all the nuances of this tax legislation, but all signs point to it being a good thing for those forced into short sale situations. I’m sure Shailesh will weigh in soon!

Updated:
Note: there are two versions of this bill, the Senate bill is S. 1394 – Mortgage Cancellation Relief Act of 2007, and the House bill is H.R. 3648 – Mortgage Forgiveness Debt Relief Act of 2007. GovTrack.US shows HR3648 has passed both the House and Senate. It shows S1394 as introduced but not even scheduled for debate.

I suspects reports are confusing the two variations of the bill. It looks like the Senate amended HR 3648, which if my memory of Civics classes serves me right, means the bill will return to the House for them to review and vote on the changes before submitting it to the President to sign into law.

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[tags]Mortgage Cancellation Relief Act, short sale[/tags]