The economic recession of 2008-2010 may be staging a slow recovery but one of the casualties of the recession has been the huge numbers of home foreclosures. With an estimated 25 percent of homes that are in foreclosure having a mortgage debt that is greater than the value of the house, some owners have given up and willingly gone into foreclosure. Others, due to unemployment or underemployment have been unable to make their mortgage payments and have been forced to default because they lacked the income to make the payments. In the case of any default and foreclosure, knowing the tax laws in advance can either help the homeowner make the right decision or provide some relief from the stress of unemployment and foreclosure.
The Internal Revenue Service and Debt Relief
In the past, when a homeowner completed foreclosure there was a good chance that the IRS was going to be waiting, looking to collect taxes on what the IRS considered as income. The tax regulations call for any debt that had been forgiven to be considered as income. If the debt forgiven was significant, it could easily move a taxpayer into a higher tax bracket adding thousands of dollars to the tax bill. While this is still the case for many debt forgiveness situations, it no longer applies to debt forgiven in a foreclosure situation.
Congress Corrects Debt Relief Taxation
As the country entered the recession and foreclosures began to increase in number, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007, and then President Bush signed it into law on December 20, 2007. The Act provided tax relief for people who had debt forgiven in a foreclosure process and allows taxpayers to exclude debt forgiven on the principal residence if the balance of their loan was $2 million or less. The limit is $1 million for a married person filing a separate return. Full details are provided by the IRS on Form 982 and its instructions and can be found on the IRS web site. While the initial act only applied to mortgage debt forgiven in 2007-2009, Congress has enacted additional legislation that has extended this out through 2012.
The Mortgage Forgiveness Debt Relief Act of 2007 requires that in order to use the debt relief tax exemption the debt must have been incurred to buy, build or improve the primary residence of the taxpayer. For those who refinanced their home only to later go into foreclosure, only the debt that was incurred in the previous mortgage is eligible for the income exclusion. Some debts that were excluded from the act include second homes, rental property, business property, credit cards or car loans.
Get Expert Advice
Whenever someone makes the decision to default on a home loan or is forced into foreclosure, they should consult with a lawyer well-versed in tax law or a good tax accountant. Every person’s situation is unique and the correct information is essential to good decision making.