In 2007, Congress created a bill that would give some tax relief to homeowners who had lost their home through foreclosure or short sale or received some type of mortgage reduction on their home. Normally, the deficiency created by the sale or refinance of a home for less money than what is owed creates a tax liability for the seller. Whatever amount the bank forgives is considered income and the seller usually has to pay taxes on that amount.
The Mortgage Forgiveness Debt Relief Act of 2007 got the homeowner off the hook and this debt was no longer considered taxable income up through 2009. The bailout passed by the House and Senate in 2008 extended that deadline through 2012.
Of course there are lots of rules attached to this; second homes are not applicable and neither are rental units. If you refinanced your house to pay off credit cards, you’re out of luck, it doesn’t apply. If you refinanced to fix up your home, that does apply. And it only applies to deficiencies of up to $1M for one person and $2M for a couple. It seems appropriate for most of us but then again, those multi-million dollar homes in California have come down quite a bit and it’s not unheard of that a homeowner is liable for a 3-4 million dollar deficiency.
You should receive a 1099-C, Cancellation of Debt from your lender. Make sure all the numbers have been filled out correctly by the lender. Don’t assume they are always right.
Real estate agents don’t give tax advice or legal advice so you should be talking to your attorney and/or accountant.
This may not apply to you but statistically you know someone it does apply to. There are just too many people out there who may have to do a short sale, or apply for a loan modification or even have to go through foreclosure in the near future. If the debt forgiveness bill is not extended past 2012, you or someone you know could end up with a tax liability that haunts them even longer than the foreclosure.
Not sure? There is an Interactive Tax Assistant on the IRS website that can help determine if your canceled debt is taxable. Make sure you go to www.IRS.gov and not one with a .com or.org. Just don’t ignore it. The clock is ticking.