Homeowners who want to negotiate a write off of too-large mortgage debt through a short sale or loan modification have been given some extra help. The recently passed “fiscal cliff” avoidance law also extends the Mortgage Debt Foregiveness Act, (MDFA) due to expire on December 31, 2012, for another year. This is the law that provides protection to homeowners doing short sales or deeds in lieu of foreclosure, under limited circumstances.
Normally, when a lender cancels part of a debt, (even after a foreclosure sale) the amount cancelled is treated as income, taxed at the same rate as a salary. This can result in a large and unwelcome tax bill unless the cancellation is due to a bankruptcy discharge or to the extent the borrower can prove
The MDFA created another exception. Those trying to work deals with mortgage lenders have another year before the “tax break” ends.
As always, the devil is in the details. The exception only applies to mortgage debt used to purchase or improve a residence. Additional debt used for other purposes is not protected, and will be counted first. This can result in a substantial tax.
There are several important considerations before embarking on a short sale or deed in lieu of foreclosure. But getting early and qualified tax advice and legal advice is essential to avoid nasty and unpleasant surprises down the orad. While we are not tax advisers, we can help you understand the issues and alternatives, and are prepared to work closely with your tax advisers.
IRS CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Regulations, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used or relied upon by you or any other person, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax advice addressed herein.