When a debt is forgiven, it normally becomes income in addition to being taxable, and while also being included on your tax return, the creditor reports it to the IRS.
The Mortgage Debt Relief Act allows you to exclude the cancelled debt of purchase money on your principal residence so you don’t have to pay tax on it. It was enacted on Dec. 20, 2007 and goes through Dec. 31 of this year. Short sales completed by the latter date will be covered under this act, and, if eligible, won’t be subject to any tax on the deficiency.
As of right now, no one knows if this act will be extended beyond 2012. So, if you are thinking of doing a short sale, you don’t want to wait much longer. Short sales, on average, take three to four months to complete (once there is a contract on the house). It may take longer, depending on different circumstances, such as who the bank is, who owns the actual loan, and if there is a second mortgage. The short sale has to be complete, and the house closed, by Dec. 31, in order to qualify for the Mortgage Debt Relief Act and not be subject to taxes.
What is the deficiency?
When a homeowner does a short sale, the bank is agreeing to sell the property for less than the amount owed, and, therefore, selling the home short. This will be an agreement between the homeowner and the bank, while the remaining balance becomes the deficiency. In a basic example, if the current balance on the mortgage is $400K, and the house is sold as a short sale for $300K, there is a $100,000 deficiency. The borrower will receive a 1099C from the bank for $100,000, and it will be reported to the IRS. With the Mortgage Debt Relief Act, this $100,000 will not be taxable. However, if the relief act is not reinstated, and the short sale closes after Dec 31, the borrower will be subject to taxes on the $100,000 deficiency.
What Is the Mortgage Debt Relief Act?
The act was designed to help homeowners, who lose their home through foreclosure or a short sale, get relief from paying taxes on the deficiency. It was implemented on Dec. 20, 2007 and goes through the end of this year, Dec. 31. You can get a complete copy of the Mortgage Debt Relief Act on my Web site.
Eligibility
The cancelled debt must be for the purchase, building or substantial improvements of your principal residence. Maximum amount of forgiven debt is $2 million, or $1 million if married and filing separately. It does apply to refinance, but only if the previous mortgage would have qualified (which, in most cases, they do).
For more information on The Mortgage Debt Relief Act and short sales, or for a free, confidential consultation, contact me directly at (602) 571-6799, or send an e-mail to Lorraine@ArizonaShortSaleToday.com. You also can visit my Web site at www.ArizonaShortSaleToday.com.