For homeowners looking to complete a Short Sale, Loan Modification or Deed in Lieu of Foreclosure an important tax deadline is looming which may change your thinking about which foreclosure option is right for you. In fact, if Congress fails to act by the end of the year one of the most effective government sponsored tools to help struggling homeowners will end and the financial crisis will worsen yet again.
Generally, few people realize that the total dollar amount forgiven by banks in short sales and loan modifications is considered taxable income by the IRS and could have a huge impact on your tax liability. Fortunately, the Mortgage Forgiveness Debt Relief Act was passed in 2007 to eliminate tax liability for 5 years when borrowers utilize one of the Ten Foreclosure Options available to stop foreclosure sales.
Under the U.S. tax code, all types of forgiven debt are treated as ordinary income and subject to regular tax rates. As a result, if your home is underwater and you owe $250,000 on your loan but complete a short sale or loan modification for $150,000, the $100,000 forgiven or reduced debt would normally be taxable. Depending on your tax rate, the tax liability in this example could exceed $20,000.
By passing the Mortgage Forgiveness Debt Relief Act in 2007, Congress wisely eliminated the need to pay taxes on income that never actually existed and allowed homeowners to truly move on once the Foreclosure Process was complete.
This critical exemption from taxable income is set to expire on December 31, 2012 and could have dire consequences for both homeowners and the real estate market overall. Should Congress fail to extend the Act, millions of stressed out American homeowners who’ve survived the foreclosure process will be hit with the double whammy of unexpected taxable income AND likely being forced into a higher tax bracket as a result of the extra income.
The obvious solution is not only extending the Act but making its provisions permanent so borrowers aren’t facing an annual guessing game about important financial issues. The good news is that the Senate Finance Committee approved a bi-partisan bill on August 2nd that would at least extend the tax relief through 2013.
The bad news is that despite Senate Committee approval, the bill must still pass the full Senate (likely) and the House of Representatives (who knows) before becoming law so the best advice is to act now if at all possible. Complete your loan modification or short sale before the end of the year or risk becoming a political pawn subject to the vagaries of an increasingly unreliable political system.
If you can’t get approval for your Foreclosure Option by the end of the year, make sure to vote for the people you think are most likely to help you and the rest of the people in our country. Sometimes collectivism makes a lot more sense than individualism and making sure that children and families have a safe and secure place to sleep at night is or should be a no-brainer.
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