What does all that mean? Before 2007, if a homeowner sold a house for less money than they owed on the mortgage, they had to declare that extra difference as income on their tax returns. For example, if a homeowner short sales his house for $100,000 but he still owes $150,000 on his mortgage note, the bank will "forgive" the homeowner the remaining $50,000.
In the past the homeowner would have had to pay income tax on that "forgiven" $50,000 but because of the Mortgage Forgiveness Debt Relief Act of 2007, the homeowner is not taxed on that money and it isn't considered income.
The Mortgage Forgiveness Debt Relief Act applies to three types of sellers:
- Short Sales - (like the scenario above)
- Principal Reduction - When a homeowner's monthly payment is reduced by the lender in order to prevent foreclosure.
- Foreclosure - A legal process where the lender attempts to collect the balance of the loan by taking possession of the property and selling it.
According to CNN/Money, over 50,000 families lose their homes to foreclosure every month. The number of short sales has tripled over the last three years to the tune of about half a million homes per year. Clearly the extension of this act will benefit some of these distressed homeowners by relieving them of the tax burdens associated with short sales and foreclosures.
Fore more information visit the IRS page dedicated to the Mortgage Forgiveness Debt Relief Act and Debt Cancellation.