Mortgage Forgiveness Debt Relief Act Ends; How Does This Impact Your Taxes?
For months now, the issue of whether or not the Mortgage Forgiveness Debt Relief Act will be extended has been on the minds of countless homeowners facing short sales as well as myriad industry professionals waiting and wondering.
Today, on the eve of the New Year – there is still no official word on the extension of this program. And while our government works at solving the Fiscal Cliff situation that looms in the air, we can only wait and watch then hope for the best. In the interim, however, it’s important to note that there are several misconceptions about the impact on this latest development, as clarified by Dan Parr, CPA.
Sellers Can Avoid Taxation on Their Short Sale in Three Ways
A common misconception centers on debt cancellation taxation in that most people neglect to realize there are three ways a seller can avoid taxes.
1. Primary Residence Exclusion
2. Bankruptcy Exclusion
3. Insolvency Exclusion
In case of primary residence exclusion, the seller owns and occupies the home and the debt cancellation is not taxable as per the Mortgage Forgiveness Relief Act. This is the area of debt exclusion that will be impacted by the new changes taking place.
Bankruptcy and insolvency exclusions result in no tax liability for dischargeable debt, regardless of the Act not being extended. With respect to insolvency, a scenario affecting many Americans doing short sales these days, as long as the seller’s net worth is less than the loss amount, the seller is considered “insolvent” at the time of sale and qualifies for the tax liability exclusion. This applies to both investment and primary residence homes.
Foreclosures and Short Sales Incur Tax Liability
A common misconception about debt cancellation and the corresponding tax liability is that foreclosures and short sales do not apply. In actuality, the same rules apply and the owner would have to qualify for one of the three tax exclusions as mentioned above.
Taxes Will Be Incurred Regardless of 1099 Receipt
Most homeowners think that if they do not receive a 1099 that represents the transaction, they are not then required to claim the debt cancellation on their tax filing. This is incorrect. The truth is that while a lender may or may not send out a 1099 income statement, it is very important that the seller report the taxable event for the year that the debt cancellation occurred.
Keep in mind that in all likelihood, the Act will be extended – of course it’s only our speculation at this point but this has been a program in action since 2007 and though we are seeing an improvement in the housing market overall, there is still much room for a full blown recovery. Perhaps in another two or three months we can expect an extension that would take into account the previous months of the year.
If you have any questions about this, or other real estate related matters – I invite you to contact us today! We look forward to helping!
For any additional tax questions, please contact:
Daniel Parr, CPA
Parr Accounting Group, Inc.
855 SW Yates Ave, Suite 101
Bend, OR 97702
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