Tax break expiring for homeowners. Federal tax law generally requires that a taxpayer who has indebtedness that is forgiven by a lender is required to claim and pay taxes on the amount of the forgiven indebtedness, which is classified as “income”. As a result, prior to 2007 homeowners whose homes were foreclosed upon or who completed short sale transactions or loan modifications which included reductions in principal indebtedness were potentially required to pay taxes on the amount of indebtedness which was forgiven in those transactions. The Mortgage Forgiveness Debt Relief Act of 2007 was passed by Congress in order to modify the law by providing taxpayers who met certain requirements an exemption from taxation on the forgiven indebtedness. That law, however, is scheduled to expire on December 31, 2013 and, unless extended by Congress, will result in the loss of this exemption and the imposition of additional and potentially significant taxes on thousands of distressed homeowners. Last year, Congress rushed to extend the law but it did so only through the end of 2013.
Since 2009 hundreds of thousands of homeowners have completed short sales and it is estimated that there are still more than 6 million homes underwater throughout the country. Although this is well below the estimated 11 million homes that were underwater at the peak of the housing crisis, it also illustrates that many homeowners are still faced with the prospect of short-selling their home.
Even if the law does expire, some homeowners will still be eligible to exclude the income from forgiven indebtedness. For example, if the debt is discharged in bankruptcy or the homeowner is “insolvent” (meaning they have more debt than assets) at the time of the debt forgiveness, no tax is due. But homeowners who are considering a short sale and their agents should take this pending expiration into account and seek competent legal or tax advice so they will be prepared for the ramifications to them, if any, that will result if the law is not extended by Congress prior to the end of the year. It is interesting to note that Maryland, which is estimated to have more than 200,000 homes with negative equity plans to extend a law that exempts its residents from state taxes even if the federal law expires. Virginia and DC do not have a similar measure.
Even if the federal law is not extended prior to December 31, lawmakers who support its extension have indicated that they will push to have it extended as soon as possible and will attempt to make its effective date retroactive to January 1. 2014.