Homeowners facing foreclosure, short sale and mortgage restructuring greatly benefit from tax debt relief.
Anyone that experienced a home foreclosure prior to 2007 also got the double whammy of a year-end tax bill from the Internal Revenue Service. The difference between what is owed on the loan and the current market value of the property is known as “debt forgiven.” This amount, prior to 2007, was considered, for tax purposes, earned income. With foreclosures skyrocketing nationwide, 1.2 million Americans were subjected to this tax in 2006. To a lot of Americans’ great relief, along came H.R. 3648, also known as the Mortgage Forgiveness Debt Relief Act of 2007, an amendment to the Internal Revenue Code.
Prior to passage of the Mortgage Forgiveness Debt Relief Act, Americans facing foreclosure would also have to endure bankruptcy in order to be relieved of the tax burden of their forgiven debt. President Bush, while signing the bill, remarked that H.R. 4638 would help Americans by “ensuring that refinancing a mortgage does not result in a higher tax bill.” He had hoped that it would give an incentive to lenders to work with borrowers on refinancing their loans in order to secure lower house payments.
Americans who experience mortgage debt reduction through short sale, foreclosure and mortgage restructuring programs have few eligibility requirements for this tax relief. The debt, whether primary or due to refinancing, must have been incurred for the purchase, construction or improvement of the primary residence. Furthermore, the residence must be considered as security for the loan. Second homes, income and rental properties, auto loans and credit cards do not qualify for the exclusion.
IRS Publication 4681 goes into great detail on what type of canceled debt is considered for relief under the Mortgage Forgiveness Debt Relief Act.
The lender is required by law to inform borrowers of the amount of canceled debt that is being forgiven. To do this they send IRS Form 1099-C to the borrow, notating the forgiven amount in box 2. This form will then be submitted by the borrower with his or her tax return for the year in which the canceled debt occurred.
President Bush had expressed hopes that the Mortgage Forgiveness Debt Relief Act would result in a greater willingness on the part of lenders to work with homeowners on refinancing their debt. Instead, the number of foreclosures more than doubled from 2007 to 2008, while the number of refinanced loans declined. Lenders are still hesitant to refinance mortgages, are reticent regarding mortgage restructuring, and homeowners are forced in even far greater numbers to foreclose on their homes.
This bill relieves qualified homeowners of federal tax liabilities only. While each state’s tax laws are different there may still be a state income tax due.