What Happens if Mortgage Relief Tax Exemption Expires?

mortgage relief tax exemptionThe mortgage relief tax exemption was introduced in 2007 to prevent distressed homeowners from getting nailed twice for the same hardship, which is losing one’s home.

The expiration of the the mortgage relief tax exemption is currently set for December 31st, 2012.  The tax exemption currently protects home owners from paying income taxes as a result of either:

  • Principle balance reduction through loan modification
  • Short sale, deed in lieu or foreclosure that resulted in bank taking loss on upside down home

Generally, when there is either a foreclosure or a short sale a taxpayer will receive either (in some cases the lender may issue both) a federal Form 1099-A, Acquisition or Abandonment of Secured Property, or Form 1099-C, Cancellation of Debt, that provide the amount of debt cancelled, information to compute gain or loss, and whether the taxpayer is personally liable for the debt.

Let’s take a look at this under a very real scenario for today’s market.

It is not unusual for distressed homeowners to have equity losses of over $100,000.

Without the exemption, you may be taxed on an additional $100,000 of income this tax year

Example:  You owe $400,000 on a home that is currently worth $300,000 or less.

  • A short sale or foreclosure would be reported as you receiving $100,000 of income from the bank
  • A loan modification that reduces the principle balance is also reported as you receiving income from the bank

According to 2012 Federal Income Tax brackets:

  • As a single person, your tax rate would be 28%, or $28,000
  • As a married couple, your tax rate would be 25%, or $25,000

A home owner that is in the middle of a financial hardship now and is unable to make your mortgage payments resulting in default or a loan modification is not likely to have an extra 25-28 thousand dollars sitting around to pay the IRS.  Being hit with this tax bill would be devastating for these families.

Final Thoughts

The economic landscape today is still very much like it was in 2007.   The threat of losing a home to default or being forced to sell a home short due to economic hardship, is still very much a reality for many home owners.

Economic recovery will not be possible without recovery in the housing market.  I am still cautiously optimistic that Washington will do the right thing and extend this exemption.

If you have any questions about this exemption, and whether or not it will affect you, feel free to send a private message, leave a public comment, live chat or give us a call.

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