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What is this law, you may ask? Stated simply the Mortgage Forgiveness Debt Relief Act waives any tax due on debt forgiveness if you are able to negotiate a mortgage modification. Without this waiver, any amount of forgiven debt will be treated as ordinary income and taxed accordingly.
Here’s an example: let’s say that you owe $100,000 on your mortgage. Your property value has gone down and you are able to convince the bank to reduce your principal balance to $80,000, The $20,000 of debt forgiveness would be considered income by the IRS and you would be taxed on this. Currently, this tax is eliminated by the Mortgage Forgiveness law, but this waiver comes to an end on December 31, 2012.
Mortgage modification is already a time consuming, difficult process. Homeowners typically apply for modifications because they are struggling financially. If these homeowners discover that they will be facing a tax bill for debt forgiveness, many will conclude that there is no point in pursuing a modification and will decide to either walk away or file bankruptcy to deal with their upside-down mortgages.
Hold on Good News
Mortgage Forgiveness Debt Relief Act Extended. Happy 2013.
You can all exhale. The Fiscal Cliff deal passed in the wee hours of last night extended the 2007 Mortgage Forgiveness Debt Relief Act which was due to expire at midnight. According to NAR, the American Taxpayer Relief Act of 2012 passed the Senate 89-9.
There was an awful lot of concern among real estate licensees and borrowers either in or considering a short sale that the tax ramifications of a short sale would change with the expiration of the 2007 law. The extension saw to it that anyone who has purchase mortgage debt forgiven in, for example, a short sale would not have the forgiven debt treated as taxable income.
There is always small print as to what qualifies, so all are encouraged to consult with their attorney for specific advice, but the current law will continue unchanged, and that is good news.
This had been a big distraction and concern for the bulk of 2012. I am not happy about how long it took lawmakers to get their act together on this, but that is the climate we are in. The result is a happy one.
Carolyn Secor is a Clearwater bankruptcy attorney and Clearwater foreclosure attorney serving Palm Harbor, New Port Richey, Oldsmar, Tarpon Springs, Seminole, St. Petersburg, and the Tampa Bay area.