We understand this week that the federal Mortgage Forgiveness Debt Relief Act of 2007, which gives a massive tax exemption to some distressed homeowners after a short sale, will be extended before it expires at the end of this year. The word comes from a Democratic Congresswoman in the know about such things. But with political polarization still entrenched in Washington, D.C., we’ll believe it when we see it.
The Mortgage Forgiveness Act, which was signed into law by President Bush in 2007 and extended by President Obama in 2009, provides an income tax exemption for the “debt cancellation” that occurs after a short sale, foreclosure or loan modification with a principal reduction. The legislation expires Dec. 31, 2012.
When a bank forgives the debt on a home, it sends the borrower a 1099 for the amount of the loss. The IRS considers it income and assesses the “ordinary income tax” rate. That could mean a tax bill of $15,000 to $35,000 after a short sale in which the bank lost $100,000.
Such a severe penalty is a slap in the face of hard-working homeowners caught up in the economic downturn that has forced many into pay cuts, furloughs and outright layoffs.
The law covers:
§ Debt cancellation on primary residences only. Investment properties and second homes do not qualify.
§ The mortgage debt forgiven must have been used to buy, build or improve the home. Cash-out refinances to remodel may qualify, But cash drawn to pay off debt or buy “toys” is not eligible.
§ The debt cancellation is limited to $1 million ($2 million for a couple filing jointly).
Californians also enjoy the benefit of the Conformity Act of 2010, which provides the same taxpayer protections but applies to state income tax. It also expires at the end of this year.
Several attempts have been made this year to extend the federal law. In February, President Obama included it in his federal budget, which has been locked in purgatory ever since. A bill backed by a bipartisan group in May never made it out of committee.
But on Aug. 2, the Senate Finance Committee finally garnered the necessary votes to approve a bill that would extend the federal tax break through the end of 2013, buoyed by the National Association of Realtors and the National Association of Home Builders. The bill, which now heads to the full Senate, includes continued tax write-offs for mortgage insurance and tax credits for home energy-efficiency improvements.
Now, it’s up to a lame-duck Congress to approve the extension before the year ends, possibly as part of the “Fiscal Cliff” Grand Bargain that must be made in the face of expiring tax cuts and new Obamacare taxes.
One thing is clear: If these tax breaks are not extended, millions of homeowners who are upside-down on the mortgages and having difficulty making their loan payments will be saddled with financially devastating tax bills.
And bankruptcy filings are likely to shoot through the roof — again. BK filings already are up 900 percent since the housing crisis began in 2006.
Want to know if you qualify for the Mortgage Forgiveness Debt Relief Act tax exemption? Call us today at 951-506-5744 and we can meet with you and see if you qualify. We can also help you better understand your options with avoiding foreclosure. Don’t wait until it is too late call us now!
