Massive Tax Bill Looming on Horizon For Homeowners Who Short-sell Their Homes

 The picture on the left shows a home that is upside down which is the term used for a qualified principal residence when the proceeds from selling the property will fall short of the balance of debt secured by liens against the property.  Besides ruining one’s credit, the debt that is forgiven is considered regular income and is taxed at the applicable rate.  I call this a “Ghost Tax”.  It is tax on your “income” that you do not have.  It is a paper income gain and the money does not exist to pay the tax.  You have to file a Form 1099-C, Cancelation of Debt with the IRS.  The most common situations where cancellation of debt is not taxable are discussed in detail in IRS Publication 4681. 

To help families who were upside down in their homes get out from under the debt and taxes owed, Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007 (MFDR). The MFDR was enacted on December 20, 2007 (see news Release IR-2008-17).  Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principle residence.  The maximum amount you can treat as qualified principal indebtedness is $2 million or $1 million if married filing separately. 

Here is the kicker, the special relief is in effect from 2007 through 2012. So at the end of the year, this legislation expires unless Congress acts to extend it. 

The current administration is proposing an extension that would apply to any amounts forgiven before January 1, 2015. At that point the government would reassess the market conditions and determine whether an extension is appropriate. As with all financial information, please get with your financial planner, or accountant to see how the law affects you.