|
In the US, federal tax laws dictate that if a homeowner owes a debt to someone, such as a lender, and part or all of that debt is cancelled or forgiven as the result of the mortgage being restructured, or the short sale or foreclosure of the property, than the amount that was forgiven by the lender must be included as income on the homeowner’s federal tax return and is taxable.
However, the Mortgage Forgiveness Debt Relief Act of 2007 allows some debt to be forgiven.This Act, which was recently extended through tax year 2012, allows individuals under specific circumstances to have excluded from income any debt that was cancelled or forgiven by the bank as the result of a mortgage restructure, short sale or foreclosure. Up to $2 million dollars of debt, $1 million if married filing separately, may be excluded on your principal residence.
For example, if a homeowner in foreclosure gets a bank to agree to take $400,000 for an original loan amount of $500,000, then the homeowner will not have to pay any federal income taxes on the forgiven $100,000 ($500,000 minus the $400,000).
The forgiveness applies only if directly related to a decline in the home’s value or the taxpayer’s financial condition. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.
The Act applies only to forgiven or canceled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the owner occupied home. This is known as qualified principal residence indebtedness.
You may be able to exclude part or all of this income if the debt was qualified principal residence indebtedness, you were insolvent immediately before the discharge, or if the debt was canceled in a title 11 bankruptcy. You are insolvent when your total debts exceed the total fair market value of all of your assets.
Debt forgiven on second homes, rental or other investment properties, business properties, credit cards, or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more detail about these provisions.
Losses from the sale or foreclosure of personal property are not deductible.
How do you know how much debt was forgiven? If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any foreclosed property.
Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.
If the amount forgiven or canceled is $600 or more, you qualify for the debt to be forgiven.Claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.
The Mortgage Debt Relief act also extends the private mortgage insurance deductions through 2010. The deduction for private mortgage insurance allows families with an adjusted gross income of $109,000 or less to deduct all or some of their premium payments.
Important Note:The Mortgage Forgiveness Debt Relief Act of 2007 is a Federal law so only applies to federal income tax filing.Some states conform to the federal law and others do not.NC state law does NOT conform to the federal Mortgage Forgiveness Debt Relief Act so if your NC home mortgage debt is forgiven by the lender, you will not be required to pay federal tax on the amount of the forgiven debt, however, NC State Dept of Revenue will tax that amount as regular income.
Talk to your lender and tax preparer to find out more.
For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit IRS.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. Taxpayers may obtain a copy of this publication and Form 982 either by downloading them from IRS.gov or by calling 800-TAX-FORM (800-829-3676).
What is an SFR?
The complex details involved with short sales and foreclosures are unique calls for specialized expertise.Contact an agent such as myself that has earned the Short Sale and Foreclosure Resource (SFR) Certification through the National Association of Realtors and who is committed to guiding you through the process, setting realistic expectations, and helping you make the right decision to avoid foreclosure.
If you are in a situation where your home is “underwater” due to falling home prices, you are unable to make your current mortgage payments and you are considering pursuing options such as a short sale, deed in lieu of foreclosure, strategic default or even foreclosure, there could be drawbacks that I, as a real estate agent, cannot advise you on.For your protection, I suggest that all homeowners:
- Obtain legal advice from a competent real estate lawyer regarding deficiency judgments
- Call an accountant or CPA to discuss short sale and foreclosure tax ramifications
Except for certain conditions pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, be aware the I.R.S. could consider debt forgiveness as income, and there is no guarantee that a lender who accepts a short sale or foreclosure will not legally pursue a borrower for the difference between the amount owed and the amount paid. In some states, this amount is known as a deficiency. A lawyer can determine whether your loan qualifies for a deficiency judgment or claim.
|
