3/23/2012 9:30 AM ET|
Lose your home, get socked by IRS?
If the mortgage debt relief law expires this year, 'underwater' homeowners who are going through foreclosure or a short sale could also get a big federal tax bill.
Losing your house may soon carry with it an added blow: a big tax bill from the Internal Revenue Service.
Anytime a lender writes off, or "forgives," debt, it can be considered taxable income to the borrower. The bigger the debt, the bigger the potential tax bill: Every $10,000 in forgiven debt could incur $1,500 to $3,500 in federal taxes, depending on your tax bracket.
If your home is $100,000 "underwater," that could mean a federal tax bill of up to $35,000. State and local income taxes could increase the pain.
In recent years, most underwater homeowners who lost property to foreclosure or short sales were excused from having to pay taxes on this income, thanks to the Mortgage Debt Relief Act of 2007.
This law says homeowners don't have to include forgiven debt as income as long as:
- The debt was secured by a principal residence. Mortgages on investment property or vacation homes don't qualify.
- The debt was "used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes," according to the IRS.
- The maximum amount that can be treated as "qualified principal residence indebtedness" is $2 million, or $1 million if married and filing separately.
The act's protections are scheduled to expire at the end of the year, however, and it's not clear when or even if Congress will get around to renewing them.
"Obama did include it in his budget, to extend it to 2014," said Mark Luscombe, a principal analyst for tax research firm CCH, a Wolters Kluwer business. "Congress . . . might decide it's not as crucial as extending the tax breaks that already expired at the end of last year."
That doesn't mean Congress won't eventually act to extend the relief, Luscombe said. "Usually the only fight about these things," he said, "is finding a way to pay for it."
But accurately forecasting what Congress will and won't do, especially in regard to taxes, is tough. Most tax experts, for example, believed lawmakers would reinstate the estate tax rather than let it temporarily vanish in 2010. But Congress failed to act, and some billion-dollar estates went untaxed.
The scheduled expiration of the mortgage debt relief law means a whole lot of uncertainty for a whole lot of underwater homeowners who are in the process of foreclosure or trying to arrange short sales.
More than 2 million properties are currently in foreclosure, according to tallies maintained by Lender Processing Services. An additional 4 million mortgage holders are at least 30 days behind.
Short-sellers may have time to complete their deals before the law expires. Banks often take three to five months to approve a short sale, with 45 to 60 days more needed for the deal to close, said John Anderson, an agent at Twin Oaks Realty in Golden Valley, Minn., who specializes in foreclosures and short sales.
If you're early in the foreclosure process, though, it may already be too late to beat the Dec. 31 expiration of the law unless you arrange a deed in lieu of foreclosure, in which you hand over your keys in exchange for being released from your debt.
Otherwise, the process may grind on for a year or more:
- Foreclosures completed in the fourth quarter of last year took an average of 348 days from start to finish, according to RealtyTrac. That's up 24% from the average 281 days in the third quarter of 2010, when lenders started re-evaluating their procedures in the wake of the "robo-signing" mess.
- Foreclosures take far longer in certain states. The average processing time in New York is 1,019 days, RealtyTrac said. New Jersey's average is 964, and Florida's is 806.
- Then again, the process is much faster in a few states: Texas, 90 days; Delaware, 106 days; Kentucky, 108 days; Virginia, 132 days; and Louisiana, 134 days.
Rushing to hand over your deed to your lender may be a mistake if Congress ends up extending the debt relief act -- or if you could qualify for a mortgage modification, a refinance under a revamped federal program or relief from the recent national bank settlement.
Also, you may not face a tax bill if your loan is nonrecourse, meaning the lender isn't legally allowed to pursue you for an unpaid balance -- and thus there are no debts to forgive. People who do face tax bills might not have to pay them if they're insolvent (if their total debts exceed the market value of their assets). Debts erased in bankruptcy court also aren't taxable.
At the very least, you should talk to a HUD-approved housing counselor about your options and perhaps consult an attorney before you decide what to do next.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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I see lots of comments here by people who don't understand tax law. I will try to straighten it out.
Generally, when people buy a personal residence using a mortgage the money they borrow goes to pay the seller of the home. At that time, the buyer signs the mortgage agreeing to repay a certain amount. When the buyer loses the home or sells it for less than it was worth, the proceeds go to pay off the fees and the mortgage. If the proceeds don't repay the mortgage in full, the lender has the option of trying to collect the difference or letting it go. If the lender lets it go, the borrower has received the "benefit" of not having to repay the debt. That "forgiveness of debt" is generally considered as income.
However, before the income is considered as "taxable" other circumstances are reviewed. Among the critical factors is the financial status of the borrower at the time the debt was forgiven. Specifically, if the remaining debt was forgiven in bankruptcy it is not considered as taxable income. Also, if the individual is "insolvent" at the time the debt was forgiven (i.e. - debts in excess of assets), the income is not taxable.
In the vast majority of cases, the people would not be considered as "solvent" if they are losing their home, so the income would not be considered as taxable by the I.R.S. The agency knows you can't get blood out of a turnip but they don't have to try in these cases.
Finally, tax laws are not written by the I.R.S. They are written by Congress. If you are inclined to disagree with the tax laws, tell it to your representative. Remember, your voice can be heard through the voting booth.
Some real morons here - I cant pay for my house so please try and get more money from me!! Has to be another huge waste of money even trying to push this one!
I need a job that gives me money for not being able to pay my bills! That sounds right to me!
Even though we waited until we were older, put a down payment down, and, bought an affordable mortgage, I still consider purchasing the house the biggest financial mistake we ever made.
Thank you Cheap Labor Reactionaries for removing the 'Dream" from American Dream then attacking the youngers when they have to move back into their parent's house.
The problem is not Capitalism. The problem is we are not conducting true Capitalism anymore. In true Capitalism there is a risk of failure. When the government removes the consequences for bad decision making. Banks and large corporations become embolden. We need to reexamine the policies of our elected officials in November. What is up with the term “Too big to fail” Weren’t the Antitrust laws implemented to insure that no entity was Too big to fail. When the last time has an antitrust suit was filed against an oversized economy sucking, taxpayer bailing, competition kicking, and selfindulgent lobbing entity. I think the last time was against AT&T in the 80s. Do not blame it on Capitalism. The blame falls to the American people for not being vigilantly aware of the run amuck corporate sponsored corruption that has infected the Democratic and Republican parties over the past 30 years in this country. It is time to clean house.
Interesting - if they take the home - the home owner gets no money - then - the home owner hasn't received anything. It isn't forgiven debt since the homeowner doesn't get to keep the home. If the owner got to keep the home it might be different.
Only some sick SOB at the IRS or those who made the rule would think otherwise. Certainly - if there ever is a breakdown of the rule of law in the US - these people will be targeted first.
Anyone wonder why so many people simply give up and don't even look for work anymore? Don't try to have a nice home or anything else. Keep in mind these people eventually turn to crime to get what they need. Then we all pay.
Ultimately all societies are just mechanisms for a ruling elite to funnel resources from a great mass of people, that they couldn't ever accumulate by themselves without help. In order to have any semblance of a decent life, you to buy into the system. (Want a job, you need a car and a phone)
Each form has its justification for funneling resources to a given elite, whether it ia a king ruling by "divine right", communist party officials driving expensive cars when there are butter shortages, or a capitalist system driven by "invisible hand".
It is towards the end of a society, when the amount of resources squeezed from the people actually working (be it a small businessman, truck driver, or factory worker) becomes next to intolerable, that the society implodes.
I'd say stuff like this is just another symptom of the end approaching. Another abuse, following other elite abuses such "free trade", jobs outsourcing, capital gains being taxed preferentially, and H1b visas being granted for foreign techworkers (allegedly to cover shortage of workers) to lower domestic salaries for programmers.
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