2007 Mortgage Debt Relief Act and Tax Implications in a Short Sale and Foreclosure

2007 Mortgage Debt Relief Made Retroactive

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The Mortgage Debt Relief Act

The Mortgage Debt Relief Act of 2007 was put in place to assist homeowners who had debt forgiven, cancelled or discharged in regards to a short sale or foreclosure or who had their mortgage reduced through some kind of restructuring (loan modification) on their PRINCIPAL RESIDENCE. So this Act applies if the forgiven, discharged or cancelled debt was used to buy, build or substantially improve your principal residence. What most people are unaware of is that when you owe someone a debt and that debt is forgiven or canceled, that amount may be taxable income. The 2007 Mortgage Debt Relief Act has assisted hundreds of thousands of homeowners in avoiding this type of taxable income.

While the foreclosure crisis is somewhat fading from the news, foreclosures and short sales are alive and well and will continue to impact the housing market for years to come. A foreclosure is where the bank has actually auctioned off a homeowner’s home and either taken it back or it is sold it to a third party. A short sale is where a homeowner sells their home for less than the amount they owe the bank. In both of these instances under the United States Tax Code, it usually involves the cancellation, forgiveness or discharge of debt, which must be included as income on you taxes.

Example: You borrow $500,000 to purchase a home and default (let’s say with the arrears you still owe $500,000). After a short sale where the house sold for $350,000 you would still owe the bank $150,000. In most short sales the banks will waive the amount of the deficiency so you would not owe your bank any money. However, this cancelled or forgiven debt is considered taxable income and this is where the 2007 Mortgage Debt Forgiveness Act came into place.

The 2007 Mortgage Debt Relief Act expired on December 31, 2013 and we had been waiting for the Act to be extended. While it was not extended, it was recently made retroactive to cover the full year of 2014. So for anyone that sold their homes in a short sale or lost it in foreclosure prior to end of 2014 you will be covered if it was your primary residence.

2015 & Mortgage Debt Relief

Going into 2015 the 2007 Mortgage Debt Relief Act currently does not apply the forgiven, cancelled or discharged debt in regards to a foreclosure, short sale or loan modification with forgiveness. While we hope Congress will act to extend it or make it retroactive there is obviously no guarantee so homeowners should just be aware of that.

While I am not an accountant and would recommend speaking with an accountant in regards to these matters there are two other ways around this potential tax liability. If you are able to claim insolvency under the Tax Code you may be able to avoid tax liability. My basic understanding of insolvency is that if your liabilities outweigh your assets you are insolvent. Many homeowners who have gone through significant financial problems may be able to meet this. The other way is by filing Bankruptcy. If the debt is discharged through the bankruptcy then you would not have any tax liability.

1099-C-Cancellation-of-Debt

Form 1099-C Cancellation of Debt

Finally, to see exactly how much debt was cancelled or forgiven your bank or lender should send you a 1099-C, Cancellation of Debt. If you look in box 2 you will see the amount the bank is canceling or forgiving. If you disagree with this amount you should contact your bank immediately.

 

Contact Peter Spino at ☎ 914-984-5315 for Debt Relief assistance in Westchester and a free Debt Relief consultation

 

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