Homeowners who have suffered through the indignity of losing their home in foreclosure may have jumped from the frying pan into the fire.
The Mortgage Debt Relief Act of 2007 enacted by former president George Bush, 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.
This relief applies to debt forgiven in calendar years 2007 through 2013. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).The act in some cases may apply to credit card debt and vehicle repossessions. IRS news release IR-2008-17 explains the act and its application.
Since its enactment in 2007 Congress has continued to extend the act so that homeowners who have obtained a principal reduction in a loan modification, participated in a short sale or lost their home in foreclosure would be exempt from tax on the forgiven debt.
Unfortunately, Congress and the President vacationed while on December 31, 2013 the act was allowed to expire. This puts the administration’s advertised desire for banks to allow principal reductions and short sales at odds with reality.
Any homeowner faced with a short sale on their principal residence should proceed with caution because if the act is not re-instated the forgiven debt will count as taxable income.
The relief is critical for struggling homeowners. Although the economy and housing market are currently enjoying a mild upswing, this delay in extending the act could dampen the reduction in the housing supply and strap unsuspecting homeowners with a huge tax bill.