Last week, the U.S. House of Representatives passed a much needed one-year extension to the Mortgage Forgiveness Debt Relief Act of 2007. The Senate is expected to take up this measure soon and will hopefully have it passed by the end of the year.
Few people, myself included, completely understand the tax code, but this concept is simple enough: forgiven debt is considered “income” for purposes of the income tax. For example, if someone lends you $500 but later decides to forgive you from repaying it, the IRS considers that $500 of taxable income.
This rule is incredibly problematic for struggling homeowners who have received loan modifications or opted to do short sales of their home to avoid foreclosure. Often, these arraignments result in the cancellation of mortgage debt for the homeowner; a necessity for avoiding foreclosure.
The problem? Many of these homeowners, who have avoided foreclosure, faced steep tax bills as a result of this forgiven debt. It is a problem not just for homeowners, but also realtors and attorneys who are stuck “between a rock and a hard place” in navigating this tricky area. Hopefully, Congress will have this important measure passed by the end of 2014.
This issue is a reminder, however, that homeowners accepting any type of loss mitigation assistance should seek the advice of a tax professional when considering their options.