Some Qualifications and Exclusions of the Tax Forgiveness on Short Sales

The Mortgage Tax Forgiveness Bill Was Signed by the President Yesterday (see the post below this)

The bill:

- Excludes the debt forgiven on a qualified principal residence from the definition of gross income subject to income tax (Sec. 2).

- Reduces the income tax breaks on most gains from the sales of non-primary residences using a formula based on the amount of time that the taxpayer actually lived in the property during the five-year period before the sale (Sec. 5).

The Mortgage Forgiveness Debt Relief Act of 2007 amends the Internal Revenue Code to exclude from gross income amounts attributable to a discharge of indebtedness incurred to acquire a principal residence.

Limits to $2 million the excludable amount of such indebtedness.

Reduces the basis of a principal residence by the amount of discharged indebtedness excluded from gross income.

Disallows an exclusion for a discharge of indebtedness on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.

Sets forth rules for determining the allowable amount of the exclusion for taxpayers with nonqualifying indebtedness and who are insolvent.

H.R. 3648, The Mortgage Forgiveness Debt Relief Act of 2007

Yesterday - the president offered a Christmas present to many people who have suffered the agony and humiliation of losing their home due to a short sale, foreclosure, deed in lieu of foreclosure or any similar arrangement that relieves the borrower of the obligation to pay some portion of their debt. He approved what passed by the Senate on December 14th - after many months of debate by the Senate..

On December 14th - the Senate passed H.R. 3648, The Mortgage Forgiveness Debt Relief Act of 2007. Initially sent to the Senate on October 4th, the Senate passed this legislation on December 14th.

When debt is forgiven on a home loan, the homeowner must normally count that debt forgiveness as income and pay taxes on it. The bill -- an amendment to H.R. 3648 creates a three-year exception for debt forgiveness on home loans – helping families already unable to meet their mortgages to avoid incurring large tax bills as well.

The bill also extends a provision allowing homeowners to deduct mortgage insurance payments from their taxable income.

In addition to tax relief for debt forgiveness and mortgage insurance payments, the bill includes:

- Tax relief for volunteer firefighters and emergency medical technicians
- Help to expand housing options for college students with children
- Protection of tax relief for homeowners after the death of a spouse
- Flexibility to help co-op tenant/owners deduct real estate taxes and mortgage insurance

The bill is fully offset by increased penalties for failure to file S corporation returns or partnership returns, and new requirements for the payment of corporate estimated taxes.

Comment -- Before - the forgiven debt from a short sale was taxable income, Individuals in already unfortunate situations most likely faced IRS actions because they did not have the money to pay the additional taxes. Even bankruptcy did not get rid of the tax burden. This legislation will relieve that additional burden and may also encourage families to work with their lender to negotiate terms for a short sale (rather than letting their home fall into foreclosure), knowing they will now not be subject to an IRS bill.