The end of the year may feel like it's a long way off, but it will be here sooner than you think. For homeowners trying to save their homes, this year's end may be more important than others. People trying to avoid home foreclosure using a loan modification or other workout may need to move more quickly to take advantage of the benefits offered by the Mortgage Forgiveness Debt Relief Act.
What is the Mortgage Forgiveness Debt Relief Act?
The Mortgage Forgiveness Debt Relief Act was passed in 2007 at the start of the nation's housing crisis. The law was designed to help homeowners caught in the crisis avoid the income taxes that would have been arisen because they had cancelled debt on their home.
Typically, if a debt is cancelled or forgiven, the amount that doesn't need to be repaid is treated as income by the IRS and is taxed accordingly. Even if a home has been foreclosed on, the homeowner would have been taxed on the amount of that deficiency.
The Mortgage Forgiveness Debt Relief Act allows people who have renegotiated their home mortgages through a loan modification, sold their home on a short sale or who had their homes foreclosed on to exclude these taxable 'windfalls' from their income. Caveats and key points of the act include:
- Up to $2 million of debt can be excluded from income - only $1 million if a married individual is filing separately
- The forgiveness act also includes secured debt that was incurred improving, building or buying a primary residence
- Refinanced debt qualifies as long as it was used to fix up the house
- The Act does not protect debt on rental properties, second homes, business properties, car loans or credit cards
To utilize the exemption, people must fill out IRS Form 982 and include it with their tax return corresponding with the tax year the debt was forgiven. Individuals will know the appropriate tax year because the lender will send them a 1099-C form for the forgiven debt.
Unfortunately, the Mortgage Forgiveness Debt Relief Act will expire at the end of 2012. The consequences for struggling homeowners and the nation's sputtering economy could be severe.
What Changes Can I Expect After the Mortgage Debt Relief Act Expires?
Currently, it does not look as though the Mortgage Forgiveness Debt Relief Act will be extended. In fact, many in Congress are opposed to extending it, claiming it will cost the country $2.7 billion in lost tax revenues. This may come as a surprise to many, who have watched Congress extend it year after year. Unfortunately, Congress has not evaluated the cost of not extending the measure, leaving many Americans on the hook for the forgiven debt.
The end of the Mortgage Forgiveness Debt Relief Act could be very serious for homeowners, especially those in California.
California is considered a non-recourse state, which means that homes sold through a short-sale are not subject to the tax in the first place because the debt that is eliminated in a short-sale is not considered forgiven by the IRS. The problem for Californians considering a short-sale on their homes is that the end of the act could substantially damage the housing recovery.
Yale finance expert, Bruce Judson, told the Huffington Post that he believes the expiration of the act will effectively stop short sales and loan modifications, because those individuals who are struggling simply will not be able to afford the taxes on their forgiven debts. This means, that extension of the Act would not result in the $2.7 billion loss in revenue claimed by Congress.
If anything, Judson fears, Americans will pay a far greater cost because the failure to extend it will effectively kill the recovering housing market. Once the housing market collapses, there rest of the nation's economy is also likely to suffer. While the exact impact is unknown, it is unquestionably serious.
This means that homeowners who are underwater with their mortgages will want to move quickly if they hope to take advantage of the Act.
What If My Loan Modification Is Not Finished By the End of the Year?
Fortunately, bankruptcy is available to help people in this situation. Whether a home has been foreclosed on or is in jeopardy of being lost to foreclosure, bankruptcy may be the best way to protect your assets.
For many Californians, bankruptcy may be the best answer because any debts discharged through it are not taxable as income. The expiration of the Act will not affect this exemption from taxation.
Depending on an individual or a family's needs, a Chapter 7 or Chapter 13 bankruptcy can help them.
Chapter 13 bankruptcy allows individuals to catch up on their delinquent home payments over a period of three to five years. In some cases, bankruptcy can be used to remove second and third mortgages.
Even if a home is already gone, a Chapter 7 bankruptcy can help families get a fresh start. The added benefit of the Chapter 7 is that it takes considerably less time to get a discharge than a Chapter 13.
Bankruptcy is complicated. Its many laws make it perilous for individuals hoping to file without legal assistance. Even determining the right bankruptcy chapter requires a thorough understanding of the pros and cons of each chapter.
Whatever your needs, if you are trying to save your home or have already lost it, it is important to talk with a Los Angeles bankruptcy attorney about your options. An experienced bankruptcy attorney can guide you through the process, making sure you understand what you are about to do and that you are ready for what lies ahead.