Strategic Default Monitor – How To Strategically Default

Sunday, January 10, 2010

Mortgage Forgiveness Debt Relief Act Protects Homeowners from Paying Federal Taxes on Forgiven Debt

UPDATE: The Mortgage Forgiveness Debt Relief Act provided relief for debt forgiveness during the calendar years 2007 to 2014. 
On December 27, 2007, President Bush signed the Mortgage Forgiveness Debt Relief Act[1] of 2007 (HR 3648) into law.

This law originally established a 3 year moratorium (now extend another 2 years to December 2012 by the
Emergency Economic Stabilization Act of 2008) that prevents any debt forgiven by a lender from being counted as income by the Internal Revenue Service (IRS). Basically, if a homeowner negotiates a short sale or any other type of debt forgiveness with a lender, the homeowner will not be liable for any taxes on the forgiven debt. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).

For example, if a homeowner in foreclosure gets a bank to agree to take $400,000 for an original loan amount of $500,000, then the homeowner will not have to pay any taxes on the forgiven $100,000 ($500,000 minus the $400,000).

As it stands, the Mortgage Forgiveness Debt Relief Act only applies to a primary residence. So second homes and investment properties are out. Still, even with a second home or an investment property you may not have to pay any tax on the forgiven debt, so long as you can prove to the IRS that you were insolvent at the time. Which may or may not be tough to do.
The Mortgage Debt Relief act also extends the private mortgage insurance deductions through 2010. The deduction for private mortgage insurance allows families with an adjusted gross income of $109,000 or less to deduct all or some of their premium payments.

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