Bay area homeowners – if you are thinking of about short sale then don’t delay the decision because mortgage forgiveness debt relief act is expiring on December 31, 2012, so it’s just one more year where homeowners are not responsible for taxes on the forgiven mortgage debt, which means if homeowners short sale their house by next year (December 2012) at less than what the owe to the bank, they can walk away free and clear and owe nothing to the bank or pay taxes on the shortage amount.

At this time, we don’t know whether the Congress will extend this for more years.  If it doesn’t extend then homeowners will be responsible to pay taxes on the forgiven mortgage amount. For example, if your mortgage balance is $800,000 but the house sells for $600,000 at the current market value then there’s a shortage of $200,000 to your bank. If you short sale by 2012 then there’s no taxes to pay but if sell after 2012 then the shortage of $200,000 will consider as your income because it’s a loss to your bank, in this situation you pay taxes on that $200,000 which will be a huge amount which will affect more to your financial situation.

According to the Mortgage Forgiveness Debt Relief Act, if a homeowner borrows money up to $2 million dollars to buy a house and does short sale due to hardship then the lender forgives the remaining balance and the homeowner is not responsible for paying taxes on the forgiven amount.  This act applies to primary residences and not for investment properties.  If you would like to know more about Mortgage Forgiveness Debt Relief Act and Debt Cancellation of 2007 then click here to view official website.

I hope it extends for another couple of years so that homeowners can avoid foreclosure and heavy taxes if they decide to do short sale after 2012, but if you think that you cannot afford any payments then consult with a professional to see if the short sale is the right choice or not.

We have helped many homeowners successfully sell (short sale) their house in bay area and avoided foreclosure.  So, if you are having difficulty in paying mortgage and wants to know your options to avoid foreclosure or have any questions on short sale then call me directly at 510-366-9405 for a free consultation to see what all options are available to avoid foreclosure.

Many homeowners asked me about the Mortgage Forgiveness Relief Act of 2007 and how this act will help them if they do short sale. These are some of the common questions I get from homeowners before they decide to do short sale and even sometimes friends ask for clarification just out of curiosity. I know it’s not always easy to read through those act and understand everything. So, here I tried to write in a simple language so that everybody can understand (I hope so..).

I’m not an attorney or CPA, it’s just my interpretation. You can check with CPA or attorney for more clarification.

According to the Mortgage Forgiveness Relief Act, which was enacted on December 20, 2007, the homeowners who sells their home “short sale”, does not have to pay taxes on the cancelled debt. This act applies from January 1, 2007 through December 31, 2012. So, it’s also means that whoever had short sale before January 1, 2007, they will not qualify for this tax cancellation relief act.

Before the year 2007, if the homeowner sells “short sale”, then IRS considered as income, even though they didn’t get cash from selling their house and those homeowners were responsible to pay taxes on the cancelled amount.

For example: if a homeowner sells their home for $400,000 and they owe $500,000 which means the lender cancelled debt is $100,000 ($600,000 – $500,000), they have to pay taxes on $100,000 according to their tax bracket.

Now, there’s a maximum cancellation amount on your short sale for this act. It will allow up to $2 million for married and $1 million if married and filing separately. This cancellation of debt is only for those homeowners who is having financial difficulties or their home value is upside down. So, this limit will qualify most of the homeowners who are doing short sale even million dollar homes. This cancelled debt is considered as income because you don’t have to repay that cancelled debt to the lender, so usually the lender reports to IRS on 1099-C, Cancellation of Debt.

According to the Mortgage Relief Act:

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

This tax relief act applies to qualified primary residence, not for second homes. It is described in Mortgage Relief Act:

Can I exclude debt forgiven on my second home, credit card or car loans?Not under this provision. Only cancelled debt used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for this exclusion. See Publication 4681 for further details.

Primary residence means where you normally lived at least 2 years out of last 5 years. You cannot claim more than one primary home at a time. As described in Publication 4681:

Principal residence. Your principal residence is the home where you ordinarily live most of the time. You can have only one principal residence at any one time.

You have to report this forgiven debt on Form 982 (Reduction of Tax Attributes). You must attach this form to your federal income tax return when you file your next tax return. You will know the cancelled amount when you get 1099-C from your lender. The amount will be on box 2 of that form. Your CPA can help you on this when you file your tax return. You can also download this Form 982 from the IRS website.

You can read the original article (Mortgage Relief Act of 2007) on IRS website.

As I mentioned earlier, I’m not an attorney or CPA, it’s just my interpretation after reading this act, always consult with an attorney or CPA for any questions.

Please feel free to comment or write your opinion/questions, I would always love any feedbacks from you.

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