The Mortgage Forgiveness Debt Relief Act

As many homeowners know all too well, it’s easy to get overwhelmed by your mortgage payments. And when the housing market takes a turn for the worse, you might even find that you owe more on your house than it’s actually worth. Thankfully, there are number of options available to help you get back on your feet or transition to more affordable housing. However, some of these options may have significant tax consequences, and it’s important to be prepared for them. One way the federal government has tried to ease these tax consequences is through the Mortgage Forgiveness Debt Relief Act, explained in detail below.

What Led to the Mortgage Forgiveness Debt Relief Act?

When the housing bubble burst in 2006, many homeowners were left owing more on their home than it was actually worth. Additionally, many people struggled to make their mortgage payments since the whole economy was doing poorly and unemployment was high. Consequently, many homeowners worked with their lenders to have a portion of the debt forgiven, or were forced to sell their home in foreclosure or a short sale.

Unfortunately, what many people didn’t realize was that the federal government counts forgiven debt as income for tax purposes. As a result, someone forced to sell their home in a foreclosure sale, with the remaining debt cancelled, would have to include that cancelled debt as income on their taxes the following year. For example, if you owed $400,000 on your home and sold it for $300,000 in a short sale approved by your lender, you would have to report $100,000 worth of income on your taxes.

What Is the Mortgage Forgiveness Debt Relief Act?

Recognizing the obvious paradox of the situation, the 2007 Congress and the Bush administration passed the Mortgage Forgiveness Debt Relief Act. As President Bush said at the time, “When your home is losing value and your family is under financial stress, the last thing you need is to be hit with higher taxes.”

Under this law, the taxpayer can exclude from income up to $2 million of debt cancellation related to their principle residence ($1 million if married filing separately). So, whether you restructure your mortgage, you’re forced to sell your home in a short sale, or you lose your house in foreclosure, you can exclude the cancelled debt from your income when you file your taxes with the IRS.

However, the exclusion for these canceled debts only applies to principle residences. So, second homes, rental homes, business property, credit cards, and car loans are not included in the Mortgage Forgiveness Debt Relief Act (though other tax relief provisions may apply to those). Additionally, the debt must have been used to buy, build, or substantially improve the principle residence, and must have been secured by that residence.

Has the Mortgage Forgiveness Debt Relief Act Expired?

Although the original Mortgage Forgiveness Debt Relief Act was only in effect through 2013, President Obama extended it through the end of 2016. Additionally, a group of U.S. Senators has introduced a bipartisan bill to extend these provisions. However, it is unclear whether President Trump will sign any such extension as part of his plan to significantly reform the tax code. If it is not extended, only those taxpayers who are insolvent or bankrupt would be able to exclude these types of debt cancellation from their income. Since the future of this tax relief is uncertain, it’s important to check in with an attorney before making these mortgage-related decisions.

Consider All Your Mortgage and Foreclosure Options

Many people are still feeling the effects of the housing crisis. If you’ve had to restructure your mortgage out of financial hardship, or you’ve lost your home entirely, the last thing you’d expect is a huge tax bill based on your forgiven debt “income.” But without the Mortgage Forgiveness Debt Relief Act, you may be paying taxes on tens or hundreds of thousands of dollars. Make an informed decision about your mortgage options by contacting an attorney experienced in foreclosures and foreclosure alternatives.