THE LAW OFFICES OF ROBERT S. STEINBERG

Practice Limited to Taxation

MORTGAGE DEBT RELIEF ACT - PART I

Posted on 03/21/2009

MORTGAGE FORGIVENESS DEBT RELIEF ACT OF 2007 PRESENTS TRICKY TAX ISSUES

 

 

Effects of the sub-prime mortgage debacle are no doubt being felt by all.  The relief granted by Congress to distressed homeowners who are released from part or all of mortgage debt obligations will present complex and tricky tax law issues that are best handled with the assistance of a lawyer experienced in tax matters.

The Mortgage Forgiveness Debt Relief Act of 2007 (Act) provided tax relief to defaulting homeowners who might otherwise owe income tax on qualifying mortgage obligations forgiven in 2007 through 2009. The Emergency Economic Stabilization act of 2008 extended that relief through 2012. 

A lender that is paid less than the full principal owed on a mortgage often decides not to personally pursue the borrower for the deficiency i.e., the amount by which the amount of the mortgage debt obligation exceeds the value of the foreclosed property.  In that case the lender is required to file Form 1099-C informing IRS and the borrower of the cancelled portion of the debt.  The amount of cancelled debt must be is taxed as ordinary income (not as a capital gain) to the obligor unless certain narrow exceptions or escape hatches are available.

One exception to taxability in the Act and extension make nontaxable debt forgiven on a qualified principal residence (QPR) with certain limitations as follows:

1.    The relief applies to debt forgiven between January 1, 2007 and December 31, 2012.

2.    Qualified principal residence is a residence as to each taxpayer meeting the same definition as under Section 121 relating to the home sale exclusion of $250,000 ($500,000 for joint returns). 

3.    The debt must be secured by a QPR and be either:

a.    Acquisition indebtedness up to $2,000,000 ($1,000,000 on a MFS return, or,

b.    Home equity indebtedness up to $100,000 ($50,000 on MFS return) to the extent that when added to other QPR debt the total debt does not exceed the FMV of the residence.

4.    The amount excluded from income reduces the tax basis of the property immediately.

 

THE PRESENCE OF COMPLICATING FACTORS MAKES DETERMINING THE TAX CONSEQUENCES OF MORTGAGE DEBT FOREGIVENESS MORE OBTUSE, FOR EXAMPLE, WHERE:

 

1.    There is accrued interest on the loan, especially on a home equity loan, that was not used to improve the residence (a cash-out).

2.    There is a foreclosure sale of short sale with expenses incurred in connection with the transaction that may or may not be added to the loan balance or sales proceeds allocated to late fees or interest.

3.    The home has been both a principal residence and vacation home.

4.    One spouse has left the home.

5.    A spouse is insolvent immediately after the forgiveness of non-qualifying debt.

6.    There is home equity debt and total debt exceeds the fair market value of the home.

7.    The home is sold at a gain following debt forgiveness.

8.    The home is sold at a loss following debt forgiveness in the same year.

9.    The lender participates in the sale of a home at a gain.

10. A single umbrella debt encumbers two residences in which the spouses reside separately.

11. The spouses are to file MFS returns following a forgiveness or foreclosure sale.

Steinberg Talks Tax, March 21, 2009. Copyright 2009 by Robert S. Steinberg, All rights reserved.

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