This is an update to a post of several days ago because the good news is that the “fiscal cliff” extended the Mortgage Forgiveness Debt Relief Act which is good news for those individuals who are short selling their homes. Also very good news is the extension of the mortgage interest deduction, mortgage insurance premiums and state and local taxes…From the National Association of Realtors:
A number of what lawmakers call extenders are in the bill. Extenders keep in place expiring tax provisions. Of most interest to real estate, the bill would extend mortgage cancellation relief for home owners or sellers who have a portion of their mortgage debt forgiven by their lender, typically in a short sale or foreclosure sale for sellers and in a modification for owners. Without the extension, any debt forgiven would be taxable, which, for underwater households, represents a financial burden.
Also extended are deductions for mortgage insurance premiums and for state and local property taxes, which, along with the mortgage interest deduction, are important tax considerations for home owners and buyers.
In two other important provisions, the alternative minimum tax (AMT) is permanently adjusted for inflation, making it unnecessary for Congress to adjust it each year. The AMT was enacted in 1969 to help ensure a minimum tax bill for high-income households that would otherwise minimize their taxes by shielding much of their income in deductions and using other tax strategies. Because it was never indexed to inflation, AMT threatens to catch middle-income households in the tax, so Congress each year adjusts it. Now the adjustment would be permanent.
From the IRS:
If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
The following are the most commonly asked questions and answers about The Mortgage Forgiveness Debt Relief Act and debt cancellation:
What is Cancellation of Debt?
If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.
To Continue Reading From the IRS website: Mortgage Debt Forgiveness Act of 2007