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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.
  • Mortgage Forgiveness Debt Relief Act – You can take a breath now…It has been extended

    Breathe-thumb-375x235-55453The “Fiscal Cliff” Bill passed by the House and Senate this week, re-authorized the “Mortgage Forgiveness Debt Relief Act“. This should delight all those facing a home foreclosure in the coming year.

    Background

    When a Homeowner owes the Bank more than the home is worth, and the home is foreclosed on, the Bank will typically issue a 1099 form. This form tells the IRS the amount of mortgage debt that was forgiven; or in other words, the amount that the Bank was still owed after the sale of the home took place.

    The forgiven or cancelled debt is treated as income. The Homeowner has to pay tax on income that he or she never actually saw.

    The Homeowner has to pay tax on the forgiven debt unless:

    1. The Homeowner filed for bankruptcy and discharged the obligation on the loan.
    2. The Homeowner meets the requirements to qualify for “insolvency”
    3. The Homeowner meets the requirements to qualify for exclusion of the income from tax per the Mortgage Forgiveness Debt Relief Act, which was scheduled to Sunset on December 31, 2012.

    Caution

    The Act does not protect Homeowners from the debt associated with every type of mortgage debt. Be especially wary and speak with an attorney if you have refinanced, the mortgage is related to a second home, the mortgage is related to a rental property or commercial property, or you have a second mortgage.

    If the home doesn’t qualify, and it is foreclosed on BEFORE a bankruptcy is filed, the homeowner may not be able to use the later filing of the bankruptcy case to avoid the tax consequence. He or she will have to rely on the “Insolvency Exception” or the Act.

    Foreclosure of the home is considered a “sale” for the purpose of determining whether there should be a capital gains tax paid. The homeowner may still have a capital gain despite avoiding income tax as result of one of the three exceptions above.

    We Can Help

    We help clients who are facing the following questions in relation to foreclosure:

    1. Clients who may need a bankruptcy and are also facing foreclosure

    If you have other debts that are causing you to consider bankruptcy and are living in a home, or own a property that will not qualify for positive treatment under the act or you will not qualify to meet the insolvency requirements to avoid the taxation on the forgiven debt…it may be wise to file the bankruptcy sooner than later in order to avoid the potential tax problem.

    2. Clients who have had the IRS create substitute returns that include the forgiven debt as income as a result of the foreclosure

    We have helped many clients who have unfiled IRS Returns and who have had the IRS create those returns with incorrect information. The incorrect information often includes the inclusion of the forgiven debt from the foreclosure as income even though the client filed for bankruptcy, met the insolvency requirements or met the requirements of the Mortgage Forgiveness Debt Relief Act.

    3. Clients who have tax debt as a result of the foreclosure

    Sometimes a person has had debt forgiven which has caused a large tax debt and there was or is no ability to use one of the 3 exceptions listed above. The tax debt is therefore accurate. For those clients, we can help develop plan to reduce or eliminate the debt depending on the overall financial situation.
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