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A federal law that has helped consumers avoid paying taxes on money they never even had is set to expire at the end of the year. If it does, homeowners who are forgiven any of their debt when they are foreclosed on will have to pay income tax on the forgiven amount.
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Forgiven ?Income? To Be Taxed
It seems crazy, but it?s true: Normally, if a homeowner owes $100,000 on her mortgage, but the property sells in foreclosure for $60,000, she will owe the IRS income tax on $40,000 ? the difference between what the property was worth and what the bank was able to recover through selling the home after foreclosing. If a homeowner makes a deal with a bank to keep her property and the bank shaves $40,000 off her mortgage, she?ll be taxed for it under that scenario as well.
But under the Mortgage Forgiveness Debt Relief Act of 2007, people were cut a break by the IRS when they were legitimately foreclosed on and the bank chose to forgive any portion of their debt, explains Todd B. Allen, a real estate lawyer in Naples, FL with Goede & Adamczyk, PLLC.
Todd B. Allen
The law also applies to modifications of people?s mortgages, including waiving any part of the principal, Allen says. All of these things the IRS would normally consider income and require income tax to be paid on the amounts forgiven. ?For the banks to cut consumers deals, but then the IRS to kick them when they?re down seems very unfair,? he adds.?
?The expiration of this law would force people to file bankruptcy or otherwise find a way to avoid paying possibly huge amounts of tax,? Allen says. ?For many people, the amount forgiven equals a whole year?s worth of salary that they?d suddenly owe tax on.?
Some of the ways to avoid these taxes are difficult to pursue and little-known even by CPAs. The IRS recognizes an insolvency exception, but in order to successfully claim that the amount of debt you are forgiven must actually put you in the black. ?Most people have additional debt, so they?re not going to be solvent even with the amount they receive as forgiveness of mortgage debt,? says Allen.
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Foreclosures: Still a Crisis
If the law expires, a lot of people could be affected: the mortgage crisis that began in 2007 is far from over, notes Allen. In many parts of the country, the foreclosure rate remains high, according to October 2012 stats from RealtyTrac. In California, Florida and Illinois, for example, the monthly rates were one foreclosure per about 350 homes.
State officials know how dire this is. Forty-one state attorneys general just last week sent a letter to members of Congress, begging them to extend the Mortgage Debt Relief Act. Its expiration, they said, will make the national mortgage settlement announced in April much less effective.
They warned Congress that if real debt relief is allowed to expire, the housing industry will be thrown into a whole new downward spiral, Allen says.
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Hope on the Cliff
Hope lies in the Family and Business Tax Cut Certainty Act of 2012 (S. 3521), which Allen notes was recently reported out of the Senate Finance Committee and is now under review in the House Ways & Means Committee.
The bill would extend the forgiveness act ? but do a lot of other things that a country teetering on a ?fiscal cliff? and needing to find sources of revenue may not be in the mood to do. The Congressional Budget Office, in its analysis of the bill, noted that its enactment ?would reduce revenues by about $205 billion over the 2013?2022 period.?
Allen says concerned consumers should contact their members of Congress and encourage them to support S. 3521, because if the mortgage crisis gets worse Congress will have an even bigger fiscal fish to fry.
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Visit Lawyers.com to learn more about foreclosure and to find an attorney in your area who can advise you.
Do you think Congress should extend the debt relief act? Share your opinion below.
Source: http://blogs.lawyers.com/2012/12/expiration-debt-relief-act-mortgage-crisis/
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