Under ordinary United States tax law, the forgiveness of mortgage debt results in a tax liability for the taxpayer whose debt is either entirely or partially forgiven. When a lender forecloses or agrees to accept a short sale or a loan refinance agreement to a lower loan amount, the amount of mortgage debt forgiven is considered to be income for the borrower and is therefore subject to taxation by the IRS. However, since the passage of the Mortgage Forgiveness Act in 2007, homeowners have been protected from this potential burden to their tax settlement. The Mortgage Debt Forgiveness Act excludes forgiven mortgage debt from becoming a tax liability in the following specific instances:
• Short Sales There is no tax on the difference between the loan balance and the selling price.
• Foreclosures There is no tax on the canceled loan amount.
• Refinancing to a Lower Loan Balance There is no tax on the difference between the original and the new loan amounts.
Although the Mortgage Debt Forgiveness Act protects taxpayers from most tax liabilities incurred from the forgiveness of mortgage debt, it includes the following exclusions and limitations:
• It does not forgive mortgage debt incurred through a home equity loan.
• It applies only to the sale, refinance, or foreclosure of a primary residence, not a rental property or a second home.
• It caps the amount of debt forgiveness it will exclude from taxation at $2 million for a married couple filing jointly or $1 million for a single person or a married individual filing separately.
The Mortgage Debt Forgiveness Act is set to expire at the end of 2012 unless Congress votes to extend it. This means that any amount of mortgage debt that is forgiven after January 1, 2013 will be considered taxable income. With this deadline in mind, a taxpayer who is considering applying for any type of mortgage debt relief should set the process in motion as soon as possible. All lenders take time to process debt forgiveness decisions and the time remaining to take advantage of the tax relief provisions of the Mortgage Debt Forgiveness Act is running out.
There are many factors to consider before making a decision to seek relief from mortgage debt. Foreclosures, short sales, and certain loan restructuring agreements have a negative impact on a taxpayer’s credit score. The lower credit score will then affect the taxpayer’s ability to purchase another home at any time in the near future. In addition, any income realized from one of the mortgage debt relief alternatives could push a taxpayer into a higher tax bracket which carries with it other tax implications. Probably the best approach to take when considering any type of mortgage debt forgiveness is to enlist the services of a qualified tax professional. Such an individual will be able to accurately weigh the effects of all of the factors affected by the decision and make a recommendation that will best fit with the taxpayer’s specific set of circumstances. The tax relief provision provided by the Mortgage Debt Forgiveness Act that is set to expire at the end of 2012 is certainly not the only point to consider.
If you have experienced a foreclosure, sold your home in a short sale, or refinanced your mortgage for less than the balance on the original loan, our experienced tax professionals can ensure that you receive the tax relief benefits you deserve. If you are considering one of these mortgage debt relief alternatives, our professionals can advise you of the potential advantages and disadvantages. Visit www.professionaltaxresolution.com for more information about debt forgiveness and other tax settlement services. Contact us by phone at (877)-889-6527 or by email at info@protaxres.com to receive a free, no obligation consultation.
