Craig Elliott asked:


“When the country runs out of money”, legendary comedian W.C. Fields once told a reporter, “then we’ll just have to print some more”. If things were really that simple, tax season would become a greater celebration than Christmas, Halloween and The Super Bowl all wrapped into one. The current financial state of the US, however, looks pretty grim for all tax payers, and particularly homes and owners who have been fighting the blunt of it these past few years. The very last thing needed when crumbling under constantly-heavier monthly payments is to be taxed if forced out of a home that can’t be paid for any longer; which is where the recent Mortgage Forgiveness Debt Relief Act comes into play.

What the Act is exactly

The 1986 Internal Revenue Code was forged in a way that did not much favor home owners trying to steer clear of impending foreclosure, in that the IRS would add “discharges of Indebtedness” to the owner’s gross income. The new bill, signed by congress on December 14th 2007 and by the President six days later, rectifies this supplemental burden by offering a three-year window in which such amounts are excluded from declared revenues.

In other words, if your family is trying to get out of debt without loosing everything, the government will not add insult to injury by taxing whatever amount you managed to strike from your overall debt.

In layman’s terms

When faced with foreclosure and/or forced to sell a home because of an inability to pay, the home-value from the sale will sometimes be less than what was initially paid; if you agree to pay 100$ for an item that you cannot sell back for more than 70$, you still owe 30$. Since banks and their managers appreciate money, they usually consider taking a little less to be better than loosing a lot; many of them will agree to let you sell at the decreased-value price and “forgive” the difference. In the eyes of the IRS though, that forgiven amount constitutes an income for the seller, and thus taxed as thought it were acquired money. That does not sound so bad on a 30$ difference, but then again very few home loans are brokered for only a hundred dollars; perspective changes when the home is paid north of 100,000$.

The Act of 2007 allows home owners to accept the bank’s generosity without the Internal Revenue Service looming behind, leaving a little bit of breathing space to re-build personal finances. Debts having been forgiven between January 1st 2007 and January 1st 2010 will not be subjected to taxation; the “overlooked” amount can go as high as two millions dollars, the IRS won’t ask for their cut.

What it means for everyone

The ensuing effect will help home owners negotiate the sale of their property even at a loss without having to resort inevitably to foreclosure; banks are after all in the money business, not the reselling of homes business. If there is a way for them to negotiate even at a slight loss and avoid the overlong process or ceasing your assets, they will go the distance to meet you half-way through. Therefore, you not only have a chance to avoid bankruptcy, you also may be able to break even from the whole ordeal, and avoid a few years of credit purgatory.

The impact will also be felt by first-time home buyers, who ordinarily would not even think of buying a home, or do it but on a collision course towards bankruptcy. The real estate market might suddenly find itself populated by more affordable housings in need of a quick sale; demand would be there to meet the increased offer. In other words, the economy will be flowing.

Who exactly does it apply to?

The temporary changes to the 1986 code concerns a mortgage used to buy a principal-residence home, and mortgage debt forgiven during the designated 3-year period. The home must have lost significant value, and the financial situation of the owner must be within the qualifying range.

In addition to help with mortgage relief, the Act also contains measures to help specific home owners more susceptible to financial doom. A surviving spouse will be allowed to shield up to $500,000 from the sale of joint property within two years following the death of the other spouse. Also, certain single parents who are full-time students will be given access to low-income housing, providing that their children do not receive exterior support. And volunteers from emergency-response services, like firefighting of medical units, will be allowed to shield local benefits derived from their services.

All said and done, the Mortgage Forgiveness Debt Relief Act of 2007 is expected to affect over 300,000 Americans struggling to keep a roof over their heads, with a 3-year window to revise, reconsider and re-negotiate.

Now, about that money printing idea…



Dora

Calum MacKenzie asked:


On December 20, President Bush signed a law that is meant to help homeowners who are facing foreclosure or who sell their homes in a short sale. Before this law, the Mortgage Forgiveness Debt Relief Act of 2007, if your bank or lender forgave a portion of your mortgage debt because the value of your home had decreased, the IRS treated the forgiveness as taxable income.

That meant that if your mortgage lender forgave $15,000 in mortgage debt because your house was worth $15,000 less than your remaining mortgage balance, the IRS treated it as earned income. When you filed your taxes, you were required to add that amount to your annual income and pay taxes on it at your regular tax rate. Just when you most needed a break, you ended up owing taxes on $15,000 in phantom income.

Not for the next three years. Under the Mortgage Forgiveness Debt Relief Act, taxpayers can exclude up to $2 million of forgiven mortgage debt on their principal residence in 2007, 2008 or 2009. If you’re married filing separately, you can exclude up to $1 million in forgiven debt from your income.

What is mortgage forgiveness?

Mortgage forgiveness is a term that has become more familiar in the real estate market over the past couple of years. In essence, anytime that a lender accepts less than the full amount of the debt owed in full payment of a mortgage, the difference between the amount owed and the amount accepted is “forgiven”.

Let’s take a look at Sue and Jim. They took advantage of a great adjustable rate mortgage to buy a home for $350,000 four years ago. The payments were manageable until the adjustable rate did what adjustable rates do - and thanks to the changes in the housing market and the sub-prime lending market, they are now facing foreclosure. To make things even worse, the best offer that they can get on the home for which they paid $350,000 is $275,000. Although they still owe $330,000 on the mortgage, their lender agrees to accept the $275,000 as full payment of the remainder of the mortgage, forgiving $55,000 of the debt.

Under the Old Rules The IRS Gets Their Cut

When a bank or other mortgage lender forgives your loan or any part of it, they send you a 1099C in the amount of the debt forgiven. You are then required to count the amount on the 1099C as taxable income along with your earned income and wages. Sue and Jim from the paragraph above would have got a 1099C from their old lender. When they file their taxes for the year, that $55,000 would be added to their earned income, adding the insult of having to pay taxes on income they never saw. Instead of relief, they’d end up owing the IRS a hefty chunk of change at the next tax term.

The Mortgage Forgiveness Debt Relief Act Changes Everything

Well, not exactly everything. If you’re forced into a short sale, you’ll still get a 1009C from your lender, and you’ll still have to file that with your taxes. Now, however, you’re allowed to exclude the forgiven amount up to $2 million ($1 million if you’re married, filing separately) from your taxable income. In other words, while it’s still counted as income, you won’t have to pay taxes on that amount of your income.

Who Qualifies for the Mortgage Forgiveness Debt Relief Exclusion?

According to the IRS, you’ll qualify for this tax exclusion whether you mortgage debt is forgiven as part of a refinancing or if it’s forgiven in connection with a foreclosure. In order to qualify for the exclusion, the following conditions must apply:



The debt forgiven must be on a mortgage for your principal residence. The principal residence is qualified based on the amount of time that you lived in it over the past five years.

The mortgage forgiveness must be because of loss of value in your home or because of a forced short sale in connection with a mortgage foreclosure. A forgiveness that is given in return for services performed for the lender is not allowed.

The debt must be forgiven between January 1, 2007 and January 1, 2010.

The debt forgiveness must be on the mortgage used to buy your home.



How to Claim the Debt Relief Exclusion

In order to claim the debt relief exclusion, you’ll need to show the IRS how much of the debt has been forgiven. That will require some calculation on your part, because the IRS wants to see the fair market value of your home as well as the amount of your mortgage that was forgiven. Often, when the lender makes out the 1099C or 1099A, they may just put the value of the loan in the field that’s reserved fair market value of the home. In some cases, the 1099C or 1099A may not include the fair market value at all.

Like your math teacher, the IRS wants to see your work. When you submit your taxes, you’ll need to include documentation of the fair market value of the home as well as your calculations. If the fair market value of your home - the price that it was sold for - is not listed on the 1099C form, you may do best to hire an appraiser to document the fair market value.

The calculations can get complex if you’ve taken out home equity loans or a second mortgage on your home as well as the primary mortgage. In this case, special considerations may apply. For instance, the income exclusion only qualifies for “acquisition indebtedness”- money that’s spent to buy your home, build a new home or that you use to make substantial improvements to your home.

Suppose you bought a house 10 years ago and paid $80,000 for it with a 100% loan. The Florida land boom was very good to you, and five years later your home had increased in value to $200,000. You took advantage of lower interest rates to do a cash-out refinance for $150,000, paid off the remainder of the original mortgage and pocketed $70,000. When time comes to sell, though, you can only get $100,000 for the property and your lender agrees to a short sale because the home has decreased in value, forgiving $50,000 of the loan amount. Can you use the Mortgage Forgiveness Debt Relief Exclusion to avoid taxes on the $50,000?

That depends, says the IRS, on what you did with the cash-out part of the loan refinance. If you used the money from the refi to pay college tuition or your daughter’s wedding, then you’ll have to pay taxes on the forgiven amount. If, on the other hand, you used it to make major improvements to your home, then it qualifies for the exclusion - but you’d better be able to prove the expenditures. If you’re audited, you may need to provide your original warranty deed, or your HUD-1 form. You may need to show canceled checks, receipts and invoices to show the cost of improvements you made.

Filing For the Debt Forgiveness Exemption

The new law came at the end of the year, after the tax forms for this year had been printed, so you won’t find anywhere on the tax forms to make the calculations you’ll need to prove you qualify for the exemption. The IRS is suggesting that those who are facing a short sale or foreclosure this year use electronic tax preparation software. The private software companies have worked hard to update their own forms so that you can do all the necessary calculations within the software, then print out the results so that you can attach them to your completed tax return.



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