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Chapter 6: The Mortgage Forgiveness Debt Relief Act of 2007 (full)

The Mortgage Forgiveness Debt Relief Act of 2007 helps sellers going through short sales

Homeowners who consider short sales need to be familiar with the Mortgage Forgiveness Debt Relief Act of 200, as well as what this piece of legislation means to them if the lender forgives the amount still owed after this transaction takes place. On September 25, 2007, this act was first introduced in Congress and then became law later in December of 2007.

The act provides relief for homeowners who would have otherwise owed taxes on mortgage debt that was forgiven after a foreclosure, short sale or other measure. The act was to provide relief for debts that were discharged from 2007-2009. Later, the Emergency Economic Stabilization Act of 2008 would extend this tax relief for homeowners for another three years, covering debts discharged from 2010-2012.

How This Act Helps Sellers

How does the Mortgage Forgiveness Debt Relief Act of 2007 help sellers that go through with a short sale? First, it is important to note that housing debt that is written off or forgiven is considered to be income by the Internal Revenue Service. Without the law, mortgage debt that has been forgiven is taxable. This not only applies to short sale transactions, but to loan modifications and foreclosures.

When debt is written off by a lender, that amount is then reported by the lender to the IRS. The homeowner then is sent a Form 1099-C by the lender that shows the amount of canceled debt. This form is sent to all taxpayers that have debt cancelled, even if they may qualify for the exemption offered by the Mortgage Forgiveness Debt Relief Act of 2007. The exemption that allows homeowners to avoid paying taxes of the forgiven amount is only for those who have been forgiven of debt that is related to their primary home. This means that mortgage on rental properties and vacation homes will not be exempt from this tax. Now homeowners have the ability to have up to $2 million in forgiven debt excluded from their income taxes in a single year.

Many homeowners do not realize that forgiven debt is considered to be income. While this act allows homeowners to exclude this amount from their income taxes, the amount of debt forgiven still has to be reported to the IRS. The forgiven debt should be reported on IRS Form 982 and then attached to the homeowner’s tax return.

The Deduction Expired in 2012

The debt relief act of 2007 was extended as a result of the fiscal cliff of 2012

The Deduction Expired in 2012

Near the end of 2012, many homeowners were panicking because Congress did not renew the tax deduction for short sales that was provided for in the Mortgage Forgiveness Debt Relief Act of 2007. Many homeowners were rushing to close out on short sales before the end of 2012 to avoid having to possibly pay taxes within the new year. Within the first part of 2013, sellers were leery of going through with short sale transactions, since the deduction had expired and had not been renewed.

Fiscal Cliff Deal Extends This Tax Deduction

With many homeowners still struggling and facing foreclosure proceedings, the recent Fiscal Cliff deal that took place in the middle of January now has extended the tax deduction for homeowners on forgiven debt. The new legalese regarding this tax deduction includes the following language:

“SEC. 202. EXTENSION OF EXCLUSION FROM GROSS INCOME OF DISCHARGE OF QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS.

(a) IN GENERAL.—Subparagraph (E) of section 108(a)(1) is amended by striking ‘‘January 1, 2013’’ and inserting ‘‘January 1, 2014’’.

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to indebtedness discharged after December 31, 2012.”

Now homeowners can continue to take advantage of this tax deduction when they go through with a short sale. The extension to this deduction may help to fuel the increase in short sale transactions, which is expected for 2013. However, sellers should keep in mind that this act is still set to expire. Currently, the new expiration date is January 1, 2014.

Next: Chapter 7: Benefits of buying a short sale home

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