There’s been a lot of talk and rumors about this one, so I figured I’d clear up a few things…this bill addresses the fact that when homeowners who are in pre-foreclosure sell their property and it is a short sale situation with the lender (the sales price is lower than the mortgage balance) then the amount of debt that the lender agrees to “forgive†is taxable income. This bill would make that “income†non taxable under certain circumstances, the 2 notable ones being: the debt was for purchase or improvement to the property (NOT credit card consolidation, if I’m reading it right) and it was your primary residence.
On October 4th, 2007, the House overwhelmingly passed this by a vote of 386-27 (surprisingly, Georgia was the only state predominately voting NO! Just FYI!)
U.S. Senator George V. Voinovich (R-OH), introduced the bill on May 15th along with Sen. Debbie Stabenow (D-MI) to change current law that forces individuals to pay income tax when they have part of their mortgage forgiven or are forced to foreclose because of inability to pay their mortgage.
Sen. Voinovich said: “Homeowners need relief and they cannot wait any longer. If we don’t get this to the president’s desk soon, the turmoil in the housing market may get even worse. We don’t want people filling out their 2007 tax returns and discovering a very frightening and expensive surprise.â€
Currently, as an example, if a homeowner has a $250,000 mortgage on their house and through a short sale negotiation the lender agrees to take only $200,000 to allow the house to sell, the homeowner may be liable to pay income taxes on the $50,000 of forgiven debt. This translates into a $7,500-$17,500 tax owed (depending on their tax bracket). Come On! If they had that much cash laying around, they probably wouldn’t have been in foreclosure to start with! So the tax code actually punished sellers who made an effort to fix the problem instead of ignoring it.
There is actually a loop-hole in the IRS tax code that says if the taxpayer is insolvent at the time they incur this debt (the day the short sale is closed and the debt is forgiven) then they will not be required to pay the tax (here’s the link to the IRS article about this topic: http://www.irs.gov/newsroom/article/0,,id=174034,00.html ) If you or one of your clients are facing this issue, please read this article and get guidance from a tax professional about your situation.
Please note…if the amount has been written off in bankruptcy (according to the IRS site) then no income tax will be due, so again, check with your tax professional.
What Still Needs to Happen?
This bill still needs to go before the Senate for approval, and then to President Bush for approval. If Bush vetoes it, the House and Senate can override his veto, and many people seem to think he would do just that…the question doesn’t seem to be if THIS part of the bill is good or not, everyone seems to agree with it, however we all know how politics can mess up a good thing. We are all waiting eagerly for this one, we’ll keep you updated…
Backstory of This Situation:
When a lender loses money in a transaction, they have 3 different ways that they can go after the borrower:
1. They can ask the borrower to sign an unsecured note promising to pay back the money.
2. They can go after the borrower for the amount of the loss in what is called a “deficiency judgmentâ€
3. They can “write off†the loss and send the borrower and the IRS a 1099 reporting the amount as income to the borrower.
Today we have addressed #3…watch for future articles about #1 & #2.
If you’re really interested in the exact text of this bill, you can read it here: http://www.govtrack.us/congress/billtext.xpd?bill=h110-1876
See you next time!
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