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Law erases penalty in debt forgiveness
Homeowners whose mortgage lenders allow them to walk away from their debt got a big break from the new Tax Increase Prevention Act just passed by Congress. Under the old law, debt forgiveness was considered taxable income in many cases - pretty painful stuff when the reason you couldn't pay your mortgage was because you didn't have the cash.
By Helen Huntley, Times Personal Finance Editor
Published January 6, 2008
Homeowners whose mortgage lenders allow them to walk away from their debt got a big break from the new Tax Increase Prevention Act just passed by Congress. Under the old law, debt forgiveness was considered taxable income in many cases - pretty painful stuff when the reason you couldn't pay your mortgage was because you didn't have the cash.
Now forgiveness of debt or resetting of terms will not be taxable if the debt was taken on to buy, build or substantially improve your primary residence. A cashout refinancing is not eligible to the extent that it exceeds the original mortgage amount.
"This is much needed," said Scott Stamatakis, an owner of Unity One, a Tampa real estate company that specializes in "short sales," deals in which desperate homeowners sell property for less than what they owe on the mortgages to short circuit foreclosure proceedings. For the deal to close, the lender has to agree to accept the buyer's bid as payment for the mortgage. These situations have become more common as real estate prices have dropped.
"It's almost an insult for a person to be in a financial bind such as foreclosure and then, when it's over, not only did they lose the house but there's an extra $50,000 to $100,000 income they have to report. It's like being kicked when you're down."
Stamatakis said lenders typically have written off the remaining debt rather than chasing the borrower for the deficiency. The result was taxable income for borrowers unless they could show they were insolvent at the time. But if they had a positive net worth (what they owned was worth more than what they owed), they were out of luck.
The law also will benefit people who stay in their homes under "workout" arrangements in which lenders agree to change the mortgage's terms to make them more favorable to the borrower. The Bush administration's plan for freezing the rates on certain adjustable rate mortgages is one example. If the law had not changed, the deals would produce taxable income.
Helen Huntley can be reached at hhuntley@sptimes.com or (727) 893-8230.
Mortgage Forgiveness Debt Relief Act of 2007 (Enrolled as Agreed to or Passed by Both House and Senate)--H.R.3648-- H.R.3648 One Hundred Tenth Congress of the United States of America AT THE FIRST SESSION Begun and held at the City of Washington on Thursday, the fourth day of January, two thousand and seven An Act To amend the Internal Revenue Code of 1986 to exclude discharges of indebtedness on principal residences from gross income, and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE. This Act may be cited as the `Mortgage Forgiveness Debt Relief Act of 2007'. SEC. 2. DISCHARGES OF INDEBTEDNESS ON PRINCIPAL RESIDENCE EXCLUDED FROM GROSS INCOME. (a) In General- Paragraph (1) of section 108(a) of the Internal Revenue Code of 1986 is amended by striking `or' at the end of subparagraph (C), by striking the period at the end of subparagraph (D) and inserting `, or', and by inserting after subparagraph (D) the following new subparagraph: `(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010.'. (b) Special Rules Relating to Qualified Principal Residence Indebtedness- Section 108 of such Code is amended by adding at the end the following new subsection: `(h) Special Rules Relating to Qualified Principal Residence Indebtedness- `(1) BASIS REDUCTION- The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer. `(2) QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS- For purposes of this section, the term `qualified principal residence indebtedness' means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting `$2,000,000 ($1,000,000' for `$1,000,000 ($500,000' in clause (ii) thereof) with respect to the principal residence of the taxpayer. `(3) EXCEPTION FOR CERTAIN DISCHARGES NOT RELATED TO TAXPAYER'S FINANCIAL CONDITION- Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer. `(4) ORDERING RULE- If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness. `(5) PRINCIPAL RESIDENCE- For purposes of this subsection, the term `principal residence' has the same meaning as when used in section 121.'. (c) Coordination- (1) Subparagraph (A) of section 108(a)(2) of such Code is amended by striking `and (D)' and inserting `(D), and (E)'. (2) Paragraph (2) of section 108(a) of such Code is amended by adding at the end the following new subparagraph: `(C) PRINCIPAL RESIDENCE EXCLUSION TAKES PRECEDENCE OVER INSOLVENCY EXCLUSION UNLESS ELECTED OTHERWISE- Paragraph (1)(B) shall not apply to a discharge to which paragraph (1)(E) applies unless the taxpayer elects to apply paragraph (1)(B) in lieu of paragraph (1)(E).'. (d) Effective Date- The amendments made by this section shall apply to discharges of indebtedness on or after January 1, 2007. Click Here for More Information from WPFLI, CPA's & Consultants Most states conform to the federal rules, but there are some exceptions. Forgiven mortgage debt is taxable income in Kentucky, Massachusetts, Mississippi and Wisconsin. Other states that also have taken different approaches are Arkansas, California, New Jersey and Pennsylvania. |
