Under federal law, homeowners who have a portion of their debt forgiven in a loan modification, foreclosure or short sale are required to pay income taxes on the amount forgiven. In some cases, struggling homeowners can end up owing tens of thousands of dollars, reducing the financial relief available to them.
Fortunately, under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers were allowed to exclude income from the discharge of debt on their principal residence. The law was extended to debt forgiven through 2014, but as of now the debt forgiveness measure is expired. Naturally, this means that homeowners who strike agreements with their lenders this year could face tax liabilities in 2016.
At this point, there are only several weeks left for homeowners to take advantage of debt cancellation tax exclusion provision for the 2014 tax year. Taxpayers should have received a Form1099-C showing the amount of mortgage debt forgiven. After the tax season is over, though, homeowners are on their own, at least until lawmakers take new action addressing the issue.
A bill currently under consideration in the senate seeks to address the fact that there are still a significant number of homeowners out there who stand to pay a significant amount in taxes on forgiven mortgage loans. The measure would extend the tax relief measure through 2016.
Taxpayers who need guidance or who run into problems taking advantage of debt cancellation tax relief should be sure to work with an experienced tax professional and, if necessary, an attorney to ensure that they are able to benefit from federal tax law. This is particularly important for those who end up facing IRS scrutiny for attempting to take advantage of debt cancellation relief.
Source: Los Angeles Times, "Mortgage debt forgiveness still a taxing issue for many short sellers," Kenneth R. Harney, Mar 15, 2015.