How the Does the Mortgage Debt Relief Act Affect You?

When you escape a debt the IRS normally counts the amount of the debt you were forgiven as income, and taxes you accordingly.  In terms of a taxable event, this could be significant to you financially if you short sale your home.

Example:  Mr. & Mrs. Jones owe $550,000 on their mortgage, but the current market value for the house is $350,000.  Faced with a transfer, they have to sell their home. Their lender allows them to Short Sale their home for the current market value even though it will net less than the balance owed on the mortgage. In agreeing to sale short, the lender also agrees to forgive the debt on the outstanding balance; in this case, $200,000. Enter the IRS, who view the $200,000 as taxable income!

The Mortgage Forgiveness Debt Relief Act addresses this very scenario, and has been in effect for the last since 2007 when the market began its collapse, throwing many homeowners into financial distress by owing more on their mortgage than what their house was actually worth in the changed market. (It has recently been extended to the end of 2013.)

This act allows a home owner a tax exclusion for the forgiven mortgage debt. Without this Act, in the scenario above, the Jones would get a tax bill on the $200,000 as though it were regular, earned income. That means a bill of somewhere around 30%, or $60,000. Quite a deep hole to fall into!

The Mortgage Forgiveness Debt Relief Act is about making it possible to get out from under financial hardship so you can get back on your feet again.

Note:  While this is fantastic news, there are some qualifiers to this tax act.  Be sure to consult a qualified tax preparer before moving ahead.  Also, another thing to consider; the state of California is expected to follow suit with their own forgiveness of debt relief. However, as of this writing, they have not yet extended this tax break on the state level. Plain English: You may get off the hook at the Federal level, but the state is not there….yet.

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So You Missed the Deadline for Debt Relief Exemption?

When you escape a debt the IRS normally counts the amount of the debt you were forgiven as income, and taxes you accordingly.  In terms of a taxable event, this could be significant to you financially.

Example:  You owe $550,000 on your mortgage, but the current market value is $350,000.  Under an a Short Sale agreement with your lender, you sell your home for the $350,000 and the remaining $200,000 is forgiven. Enter the IRS, who view the $200,000 as taxable income!

The Mortgage Forgiveness Debt Relief Act addresses this very scenario, and has been in effect for the last 5 years for distressed home owners who short sell  their homes between 2007 and 2012. This act allows a home owner a tax exclusion for the forgiven mortgage debt. However, the measure is due to expire at the end of 2012 with a very good chance it will NOT be extended before the end of this year.

We are still 2.5 months from the end of this year–the deadline to close so that you can benefit from the current Mortgage Debt Relief Act.  Getting from listing to close in that time is a challenge  but may be doable depending on your lender.

One advantage you have right now is that the inventory of available homes for sale in Sonoma County is drastically low.  Buyers are competing aggressively for homes and that is pushing the prices up.  Depending on your lender, it may be possible still to accomplish a short sale in time so that you don’t have to hope that the bill is extended next spring.

But if you missed it, and there is a chance you may at this stage…have some hope.

It is believed that the law may be retroactively extended in spring of 2013. So, if you talk to your accountant, you may find that by going ahead with your short sale and doing an extension next year, you would be able to claim the benefit after all.  There is still a chance that it won’t be renewed, but if a Short Sale is definitely in your path, then this gives you an added chance to avoid penalty.

By extending your tax return to October 15th, 2013, if the law is extended retroactively in the first half of 2013, you may then be able to exclude the forgiven amount. Remember: consult with a tax professional before deciding.

Tax Break that Could Save You Thousands is Due to Expire!

Important Federal tax break for some homeowners set to expire this year

For the last five years, the federal government has given tax breaks to distressed homeowners who work out a deal with their lender to reduce or release mortgage debt. But unless members of Congress agree to an extension, starting next year any break you get on your mortgage debt will be considered taxable income.

In distressed mortgage situations like we’re seeing across the country, the lender’s financial loss is considered a financial benefit to the homeowner who gets out of paying their full debt. In a short sale for example, where your mortgage balance is $300,000 and your home sells for $240,000, the outstanding balance of $60,000 is considered forgiven debt and would ordinarily be ruled taxable income.

But since 2007, under the Mortgage Forgiveness Debt Relief Act, forgiven debt has been tax free. That’s set to change after the end of this year.

“As it stands, mortgage debt that’s forgiven is not going to be treated as taxable income here in 2012,” said Greg McBride of Bankrate.com. “But, it remains to be seen whether that’s going to be continued into 2013 or not.”

McBride advises anyone facing a distressed mortgage situation to get things worked out before the end of the year, in case the federal tax break is not extended so you’re not caught by surprise.

What qualifies for the income tax break? Short sales, loan modifications, deed in lieu transactions — where you turn your home over to the bank — and in many cases, foreclosure. Just keep in mind the Debt Relief Act only applies to principle residences. No rental property or second homes.

And don’t even think about getting a break on canceled credit card debt or other consumer loans.

“For somebody who is currently going through some sort of program where they’re having debt that’s forgiven, if it’s not real estate debt, there’s a real good chance you’re going to get a 1099 form at the end of the year that says you now have to pay taxes on whatever debt was forgiven, because it’s treated as income,” McBride explained.

The U.S. Treasury Department is urging mortgage services to put pressure on Congress to extend the tax break. President Obama’s proposal calls for an extension into 2015, but right now, there’s no guarantee.

via Important tax break for some homeowners set to expire 

Think you may not make it in time?  Read this post.