Morris Peacock, Managing Partner with HintonBurdick CPAs & Advisors said that, "As the economy continues its downward spiral, more and more homeowners are finding themselves facing foreclosure. Those in this situation have been given a gift by Congress called The Mortgage Forgiveness Debt Relief Act of 2007.” Before this Act, the general rule regarding forgiven debt was that the debt was included in taxable income. Therefore, taxpayers were not only losing their homes, but they were also getting hit with a huge tax bill.
“The Mortgage Forgiveness Debt Relief Act of 2007 has provided some relief to those who have lost a home to foreclosure or short sale. The revised law, which applies to “the forgiveness of debt” occurring on or after January 1, 2007 through December 31, 2012, allows homeowners to exclude from income forgiven debt up to $2 million ($1 million for married filing separate) on qualified loans,” continued Peacock.
The amount of debt forgiven will only apply to qualified principal residence debt. Qualified principal residence debt is defined as debt incurred to acquire, construct, or substantially improve a qualified residence. Qualified principal residence debt includes refinanced debt up to the amount of the old mortgage just before the refinance. Please note that proceeds from a refinance or home equity loan, unless the proceeds were used to acquire, construct, or improve your residence will not qualify under these rules. Therefore, these forgiven loans are required to be included in your taxable income.
The Debt Relief Act only applies to a principal residence. Your principal residence is determined by where you spend the greatest number of days. If one owns a vacation home, rental home, or investment property that goes through the foreclosure process and debt is forgiven, the taxpayer will have taxable income up to the amount of debt forgiveness. According to Peacock, “An example is, if a taxpayer has a loan of $200,000 on a piece of investment property now worth only $170,000 and the bank forecloses on the property and sells it then the taxpayer has taxable income of $30,000. If the property is the taxpayer’s principal residence, the taxpayer could exclude the entire $30,000 from income.”
It appears that Congress is showing some sympathy to those unfortunate enough to lose a home. As long as it’s a principal residence with qualifying debt, the taxpayer won’t have to recognize income upon foreclosure.
If you have any questions regarding the Mortgage Forgiveness Debt Relief Act of 2007, HintonBurdick would be happy to assist you.
