President Bush signed into law today a new measure giving tax breaks to homeowners who have mortgage debt forgiven. Under preexisting law, the debt forgiven by a lender, such as for short sales and refinances, was generally taxable to the borrower as debt discharge income.
With the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer does not have to pay federal income tax on debt forgiven for a loan secured by a qualified principal residence.
This tax break applies to debts discharged from January 1, 2007 to December 31, 2009. Qualified principal residence indebtedness is debt incurred in acquiring, constructing, or substantially improving the residence (up to $2 million).
For purposes of calculating capital gains, any debts discharged excluded from income under the new law must be subtracted from the basis of the taxpayer’s principal residence (but not below zero). However, taxpayers may generally exclude from capital gains income up to $250,000 (or $500,000 for married couples filing jointly) for properties owned and used as their principal residence for at least two of the last five years.
6 Comments
The web is flooded with advice regarding tax consequences after a foreclosure or a short sale. The terms that are repeatedly mentioned are recourse and nonrecourse debt. How does a consumer identify these loan types and is it the responsibility of the loan officer or mortgage broker to explain the tax consequences in “plain talk” before the borrower agrees to the terms of the loan?
The official answer to your comment is this: a consumer should definitely seek out the advice of a qualified tax accountant with questions concerning the tax consequences of foreclosures and/or short sales. It is not the responsibility of the loan officer or mortgage broker to explain the tax consequences before the borrower agrees to the terms of the loan. It is further assumed when a borrower completes a transaction in real estate, that he or she had received the necessary consultation to make an informed decision.
Does the Mortgage Forgiveness Debt Relief Act apply to a short sale of a second home? If not, what happens then?
Arlene – No, this does not apply to a short sale of a second home or vacation home – primary residence only. The IRS will treat forgiven debt as income.
Also, at this point, California has not passed any Mortgage Forgiveness Relief, so the forgiveness only applies to federal taxes.
What if your company is relocating you. If they buy the house, they will only buy it at the appraisal value. If there is still money owed, does the seller qualify for the Debt forgiveness Act? Also, when we refinanced, it was to get caught up on the high property & city taxes. The money was not used for our entertainment, and it was also not used for home improvements.
Thanks.
If your company buys the house through a short sale, it still needs the approval of the lenders. So, it is still a short sale and falls under the Debt Forgiveness Act – as long as it is your primary residence. The DFA has nothing to do with refinancing for whatever reasons.