Mortgage Forgiveness Debt Relief Act of 2007 and the Fiscal Cliff – Part I

January 14, 2013 By Elliot S. Schlissel

The 2007, Mortgage Forgiveness Debt Relief Act exempted homeowners from paying income taxes on any portion of their mortgage that is either forgiven in foreclosure, eliminated it in short sale or reduced in a principal reduction agreement entered into between homeowners and the financial institution. This has been a tax break that has saved homeowners tens of thousands of dollars in Federal Income taxes. Most homeowners are unaware that any reduction in the amount of their mortgage would be considered income to them and taxable by the Internal Revenue Service.

Example

Let’s assume that you purchased a home for $350,000. Unfortunately, it goes into foreclosure. Let’s assume you took out a $300,000 mortgage on your home and at the time of the foreclosure sale, you owed $250,000. At the sale, the home sells for $100,000. Therefore, there would be $150,000 of your mortgage that would not be paid. Under the present law, the Mortgage Forgiveness Debt Relief Act of 2007, your financial obligations to pay income taxes on this $150,000 are eliminated. Once this statute expires, you would have to pay income taxes on the $150,000. Now let’s assume for purposes of this discussion your income tax rate was 30%. This would cause you to pay $45,000 in income taxes as a result of your home being sold in foreclosure. This would be a shock to most homeowners!