From December 2014:
Senate extended Mortgage Forgiveness Debt Relief Act in the 11th hour
December 26, 2014 12:30PM
"The federal tax code treats forgiven debt as ordinary income to the borrower, taxable at regular rates. But under an exception that took effect in 2007, qualified home mortgage debt that is canceled by a lender as part of a short sale, loan modification or foreclosure is treated as non-taxable. However, that exception expired last Dec. 31 and its renewal has been in doubt all year — leaving short-sellers such as Foster unsure whether they would be facing crushing taxes in 2015."
Thousands of Americans who completed short sales during 2014 and received cancellations of mortgage debt by banks had reason to celebrate when the Senate extended the exception for transactions just before adjourning for the holidays. According to data prepared for this column by research firm RealtyTrac, nearly 122,000 short sales went to closing nationwide between January and October, involving an estimated average debt forgiveness of about $88,500. The average seller had a mortgage balance one and a half times higher than the market value of the house.
In a short sale, an underwater homeowner agrees to sell the property to a new purchaser, typically for a price well below what is owed to the bank. If the bank agrees to the sale, the proceeds pay off part of the loan balance and the bank forgives — writes off — the rest.
Richard Eastern, CEO of Washington Property Solutions Inc. in Bellevue, Washington, a brokerage specializing in short sales, says people such as Foster are the lucky ones. Substantial numbers of owners have been rushing to beat the Dec. 31 deadline. “I got a call today from a client who asked, ‘we’re still scheduled for Dec. 29, right?’” Eastern recounted. The typical client served by his firm is an underwater owner with $300,000 of mortgage debt on a $200,000 house.
But Eastern said he has dozens of other listings where a 2014 closing won’t be possible, and some of these clients “are now devastated” in the wake of the Senate’s limitation of the extension to 2014 transactions only. They could be plunging into a federal tax policy black hole when they complete their sales next year, uncertain of any further extension of the debt forgiveness law.
Eastern is mystified that Congress could not have lengthened the extension to two years — retroactive for 2014 and good through Dec. 31, 2015 — a provision approved in a bipartisan vote by the Senate Finance Committee last summer. He predicts that without protection from heavy tax burdens, many underwater owners will opt instead for bankruptcy filings. In some cases, they might be able to qualify for an “insolvency” declaration, which could wipe away tax liability for unpaid mortgage balances.
How do you know whether your short sale, loan modification or foreclosure
is covered by the extension for 2014?
Though a tax professional familiar with the law should be your best guide, here are the key tests you’ll need to pass:
The house securing the mortgage debt must be your principal residence.
The maximum amount of debt that qualifies for relief is $2 million
($1 million if you are married filing taxes singly.)
Any portion of the mortgage debt forgiven that was used for purposes
other than improving or building the house — say you refinanced,
pulled cash out and used it to buy
a car — will not qualify for the exclusion and may be taxable.....
From 2012: http://blogs.lawyers.com/2012/12/expiration-debt-relief-act-mortgage-crisis/
Forgiven “Income” To Be Taxed
It seems crazy, but it’s true: Normally, if a homeowner owes $100,000 on her mortgage, but the property sells in foreclosure for $60,000, she will owe the IRS income tax on $40,000 – the difference between what the property was worth and what the bank was able to recover through selling the home after foreclosing. If a homeowner makes a deal with a bank to keep her property and the bank shaves $40,000 off her mortgage, she’ll be taxed for it under that scenario as well.
But under the Mortgage Forgiveness Debt Relief Act of 2007, people were cut a break by the IRS when they were legitimately foreclosed on and the bank chose to forgive any portion of their debt, explains Todd B. Allen, a real estate lawyer in Naples, FL with Goede & Adamczyk, PLLC.
The law also applies to modifications of people’s mortgages, including waiving any part of the principal, Allen says. All of these things the IRS would normally consider income and require income tax to be paid on the amounts forgiven. “For the banks to cut consumers deals, but then the IRS to kick them when they’re down seems very unfair,” he adds.
“The expiration of this law would force people to file bankruptcy or otherwise find a way to avoid paying possibly huge amounts of tax,” Allen says. “For many people, the amount forgiven equals a whole year’s worth of salary that they’d suddenly owe tax on.”
Some of the ways to avoid these taxes are difficult to pursue and little-known even by CPAs. The IRS recognizes an insolvency exception, but in order to successfully claim that the amount of debt you are forgiven must actually put you in the black. “Most people have additional debt, so they’re not going to be solvent even with the amount they receive as forgiveness of mortgage debt,” says Allen.