Posted on December 18, 2012
Recently, we have heard a lot about the "fiscal cliff" set to happen at the end of 2012 unless Congress acts to mitigate it. One of the most uncertain aspects of this "cliff" is the scheduled end of the Mortgage Debt Relief Act, which could have significant consequences for distressed property owners.
Under regular federal law, any mortgage debt that is forgiven is taxed as regular income whether it is from a short sale, foreclosure, loan modifications, or something else.
As an example: If a homeowner has a mortgage loan for $500,000, but they get lender approval for a short sale at $300,000, the forgiven amount of $200,000 is considered money earned by the homeowner, and is taxed at normal federal income tax rates.
In 2007, Congress passed the Mortgage debt Relief Act, which excuses the taxes owed on this forgiven debt. By doing so the burden on underwater homeowners is reduced.
This temporary bill is set to expire at the end of December 2012, and it is unclear whether Congress will renew and extend this tax relief. So, what does this mean for you?
Well, if the Mortgage Debt Relief Act is extended, homeowners who are attempting to complete a short sale or loan modification, or who are waiting for a foreclosure, may still be eligible to have their forgiven debt written off.
On the other hand, if the Mortgage Debt Relief Act expires at the end of 2012, homeowners whose short sales, loan modifications, or foreclosures are completed in 2013 or later will be responsible for income taxes on the forgiven debt. This "phantom income" is taxed as ordinary income. This includes properties that went into contract during 2012!
Of course, we are all waiting and watching Congress to see what they will do regarding the Mortgage Debt Relief Act. Come back and visit my blog regularly and watch for updates over the next few weeks as we find out more!