Underwater Homeowners and the End of the Mortgage Forgiveness Debt Relief Act

The Mortgage Forgiveness Debt Relief Act became federal law in 2007. It allowed taxpayers to not pay income taxes on unpaid mortgage debt, including debt reduced through mortgage restructuring or foreclosure.

For example, let’s say one’s home was sold by the bank in a foreclosure sale for $100,000 less than the balance owed. The bank can seek a money judgment for the $100,000, or if it deems the homeowner to be uncollectible, it can “write off” the $100,000 for tax purposes. To do this, the lender would file a 1099C in the name of the homeowner, but because of the Act, the Internal Revenue Service would not consider this a taxable event to the homeowner.

This is The End finnances

Congress has twice extended the Act, but according to Senator Bill Nelson (Dem- FL), it will not be extended beyond December 31, 2013. Senator Nelson was the major proponent of the two previous extensions, but because of a lack of support from Senators whose states have significantly recovered from the housing crash, there are just not enough votes to keep the Act alive in 2014.

What does this mean? The Internal Revenue Service considers a debt listed on a 1099C as “Cancellation of Debt” (COD) income. Affected homeowners will pay income taxes on mortgage amounts forgiven by their lenders. Taxes will be paid on mortgages that are unpaid because of a short sale or a loan modification as well.

Not all COD income must be included in gross income. There are only two major exceptions for consumers:

  • If the taxpayer is “insolvent” at the time the 1099C is issued, or
  • If the taxpayer discharges the debt in bankruptcy
Insolvency Exception to the Rule

According to IRS guidelines, a taxpayer is “insolvent” only if total liabilities exceed the fair market value of assets.

For example, if a taxpayer has $100,000 in liabilities, but only $50,000 in assets, they are considered insolvent under the Internal Revenue Code. If a debt of $60,000 was cancelled, the taxpayer will have $10,000 in gross income because total liabilities no longer exceed total assets because cancelling $60,000 in debt means the taxpayer now has only $40,000 in liabilities.

Keep in mind that “assets” include any and all assets – even retirement accounts and encumbered assets (like a car with a lien on it).

Bankruptcy is Better small house

The criteria for the insolvency exclusion are considerably more strict than those used under bankruptcy law. For example, any and all money in a qualified retirement account such as an I.R.A. or 401(k) is exempt from creditors and not included in bankruptcy. Also, the value off assets in a bankruptcy estate is offset by any liens encumbering the asset - such as a car that is not paid off.

Parker & DuFresne, P.A. often files bankruptcy for “wealthy” people who are seeking asset protection in Bankruptcy Court, and it is possible for a wealthy person to avoid this tax liability in bankruptcy without sacrificing any assets or income. For more information, we encourage you to read Chip Parker’s article entitled Bankruptcy As An Asset Protection Tool.

If you have an underwater mortgage, we would like to talk to you. Get a free in-person or telephonic consultation with a knowledgeable attorney at Parker & DuFresne, P.A. to better understand and deal with the ramifications of the expired Mortgage Forgiveness Debt Relief Act.

Parker & DuFresne, P.A. serves bankruptcy clients residing in the following counties: Baker, Bradford, Citrus, Clay, Columbia, Duval, Flagler, Hamilton, Marion, Nassau, Putnam, St. Johns, Sumter, Suwannee, Union and Volusia.

If you are being impacted by the expiration of the Mortgage Forgiveness Debt Relief Act, it is imperative that you be pro-active in seeking the legal advice and representation of an experienced attorney at Parker & DuFresne, P.A. as soon as possible. Protect your legal rights today by contacting Parker & DuFresne, P. A. at 904.733.7766 or at www.jaxlawcenter.com to schedule a free and confidential bankruptcy consultation.

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