Many people have heard about the nation’s “Fiscal Cliff” with tax and spending changes that would have a large impact on the economy. One change people often overlook in this debate is the Mortgage Debt Relief Act of 2007, that will be extended and will expire on December 31, 2013. There are still many “underwater” homes where homeowners need to move or can no longer make the mortgage payments. A short sale offers a solution to selling an underwater home, where the bank forgives the difference between the amount owned and the amount received in the short sale transaction. The bank is required to file Form 1099C with the IRS and send the homeowner a copy showing how much debt is forgiven. If there are no exceptions or exclusions that apply, the amount reported on the 1099C is included in the taxable income of the homeowner. In some cases the debt forgiven is more than $200,000.00. If this amount is added to the income of homeowner, the homeowner may be pushed into the “Top 2 Percent” and have this “income”, and the rest of their income taxed at a very high rate. The Mortgage Debt Relief Act addressed this problem and allowed homeowners in this position to exclude forgiveness of debt income on their primary residence.
In some cases it is not a short sale, but a foreclosure that pushes a homeowner out of their home. In Arizona any resulting deficiency debt on the first mortgage is usually canceled, not forgiven, under Arizona’s anti-deficiency laws. When there is a second mortgage, or a mortgage that falls outside the anti-deficiency laws, however, the debt remains. In some cases where there is financial hardship, a lender will settle the debt for a small percentage of the balance, and forgive the remainder of the loan. The forgiven part can be taxed, and the tax on the forgiven debt may be higher than the settlement. The Mortgage Debt Forgiveness act, which is now extended to the end of 2013, solves this problem for debt on your principal residence. If you are negotiating other debt, however, you need to be prepared for the tax consequences.
One way to avoid most of the tax consequence for all of the above problems is to wipe out (discharge) the debt in bankruptcy. When debt is discharged in a bankruptcy, there is no tax consequence, and if a 1099C is sent based on the discharged debt, the “income” listed on the 1099C is excluded from taxable income.
The Mortgage Debt Relief Act of 2007 has been extended for one more year. If you are facing challenges with debt on your home or other debt, 2013 is the year to resolve this debt.
Each person should seek the advice of legal and tax professionals before making decisions regarding forgiveness of debt or bankruptcy. The Carroll Law Firm offers a free consultation regarding debt reduction. We would be pleased to help you resolve your debt issues in 2013.
