Monday, March 5, 2012

Will Mortgage Debt Relief Act be Extended Beyond 2012?

Would be good for you to understand a little bit in case you have a client who can't sell and is facing foreclosure.  Beyond these simple facts - call in a pro to explain to your client.

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.

How long is this special relief in effect?
It applies to qualified principal residence indebtedness forgiven in calendar years 2007 through 2012.  However, Obama's 2013 budget proposal includes a request that the Act be extended. This would definitely be good news for anyone still on the fence about listing their home as a short sale. So, in turn, this would be good for agents scoping out prospective short sale listings as well.

The budget proposal includes an extension that would apply to any amounts forgiven prior to January 1, 2015. At that point, the government would reassess the market and determine whether another extension is appropriate. This would be the second extension of the original bill. And, given the current state of the real estate market, it may not be a bad thing for homeowners who are underwater to have more time to consider all of their options with respect to their mortgage debt.

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.

Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
No. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness. The maximum amount you can treat as qualified principal residence indebtedness is $2 million or $1 million if married filing separately.

Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to refinance a home?
Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. For more information, including an example, see Publication 4681.


Is there a limit on the amount of forgiven qualified principal residence indebtedness that can be excluded from income?
The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately for the tax year), at the time the loan was forgiven. If the balance was greater, see the instructions to Form 982 and the detailed example in Publication 4681.



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