Relief From Indebtedness Tax on Foreclosure and Short Sales

On December 20, 2007, the Mortgage Forgiveness Debt Relief Act of 2007 became law. This new law will protect some but not all foreclosed homeowners from a tax liability when debt is forgiven in a home foreclosure or short sale. Before passage of the Act, cancellation of debt from foreclosure or short sale (sale of a home for less than the amount owed) generally resulted in significant and often unexpected tax liability based on the difference between what the home was sold for and the amount of the total debt.

Prior to the passage of the Act, the dollar amount of the mortgage amount forgiven in a short sale or the gap between what the lender realized on the sale of the property after foreclosure and the mortgage debt and expenses and fees of foreclosures, would be reported on a 1099 to the IRS as forgiveness of debt income. The former homeowner, unless able to demonstrate the he or she was insolvent at the time of the foreclosure or short sale, would owe federal income tax on the reported 1099 income. The prior tax liability was a nasty second hit for the person who had already lost their home.

The law affects: (1) foreclosure of a personal residence, (2) only to the extent the debt went into buying or improving the house, and (3) only where a foreclosure or short sale occurs between January 1, 2007 and December 31, 2009. Second homes, vacation homes, business and investment property are not included in the relief provided under the Act; it will only apply to debt secured against the qualified principal residence of the taxpayer. If a taxpayer has two homes, only the home that is used the majority of the time will qualify in most circumstances. Also, there is limit on cancellation of debt a homeowner can claim before it becomes taxable, although such amount is generous for most homeowners. The limits are $2,000,000 for a couple filing jointly or $1,000,000 for a single taxpayer or a married taxpayer filing a separate return.

Many consumers will still get hit with a tax bill after the foreclosure of their real estate loans. The first big problem will be that only debt from buying or improving the principal residence is covered by the new law. When home values were skyrocketing and sub-prime loans were prevalent, it was quite common for consumers to take out a second mortgage or home equity line of credit to consolidate high interest credit card debt. Few will have refinanced their homes without paying off outstanding consumer debt; in many cases, it would have been a requirement of the lender. This portion of the home debt will continue to trigger tax liability when the loan is foreclosed.

A careful analysis of the loan history and actual expenditures made by a debtor must be made before a foreclosure or short sale takes place. The failure to act in accordance with the Act could result in tax liability on top of loss of the home.

THIS COMMUNICATION IS NOT INTENDED TO PROVIDE LEGAL ADVICE AS TO ANY PARTICULAR TRANSACTION, AND IS INTENDED SOLELY FOR GENERAL INFORMATION. YOUR RECEIPT OF THIS INFORMATION DOES NOT CREATE ANY ATTORNEY-CLIENT RELATIONSHIP. YOU SHOULD CONSULT WITH AN ATTORNEY OF YOUR OWN CHOOSING BEFORE RELYING ON ANY OF THE STATEMENTS MADE.

This article has been provided by Ben Hamburg. Hamburg Law Corporation. You may contact Ben at 510-985-2600 or email him at ben@hamburglawcorp.com.

Sincerely,

Your CWC Financial Loan Team
888-711-5454 Toll Free / info@cwcfin.com / 415-454-1130 Local