Blown Mortgage

If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!

Back in April Congressmen Robert Andrews (D-NJ) and Ron Lewis (R-KY) introduced a bill to the House of Representatives called The Mortgage Cancellation Act of 2007 which called for the elimination of IRS tax penalties on “debt relief income” as it relates to the sale of your home. This is a substantial change to the existing tax code aimed a providing people who sell their homes in a short sale situation relief from additionally-incurred income tax. The bill has been referred to the Ways and Means Committee for review. From the bill:

To amend the Internal Revenue Code of 1986 to exclude from gross income of individual taxpayers discharges of indebtedness attributable to certain forgiven residential mortgage obligations.

Current IRS code requires debt relief to be taxed as gross income. If you sell your home but are unable to sell it for an amount more than the existing mortgage on the property your lender is supposed to issue a 1099 to you in the amount of the difference between the mortgage and the short sale amount. This dollar amount then becomes taxable as gross income and must be included in earnings calculations for the year in which the relief was provided.

The new bill will eliminate that debt relief as taxable income. From the bill:

(h) Qualified Residential Indebtedness-

`(1) LIMITATIONS- The amount excluded …with respect to any qualified residential indebtedness shall not exceed the excess (if any) of–

`(A) the outstanding principal amount of such indebtedness (immediately before the discharge), over
`(B) the sum of–
`(i) the amount realized from the sale of the real property securing such indebtedness reduced by the cost of such sale, plus
`(ii) the outstanding principal amount of any other indebtedness secured by such property.

`(2) QUALIFIED RESIDENTIAL INDEBTEDNESS-
`(A) IN GENERAL- The term `qualified residential indebtedness’ means indebtedness which–

`(i) was incurred or assumed by the taxpayer in connection with real property used as a residence and is secured by such real property,
`(ii) is incurred or assumed to acquire, construct, reconstruct, or substantially improve such real property, and
`(iii) with respect to which such taxpayer makes an election to have this paragraph apply.

`(B) REFINANCED INDEBTEDNESS- Such term shall include indebtedness resulting from the refinancing of indebtedness under subparagraph (A)(ii), but only to the extent the refinanced indebtedness does not exceed the amount of the indebtedness being refinanced.

A couple of thoughts on this bill:

In general I think it is a good idea. People who are forced to sell their homes at a value less than their mortgage are already in a bad spot - an extra kick to the shins with a nice additional tax liability is not helping anyone here. There is little chance of that tax being collected (if you’re in short sale you don’t have an extra $5,000 lying around for taxes) and it just makes a bad situation even worse.

I do have a couple of problems with it as written however.

• The bill is written to apply to any residential property used as a residence by the taxpayer. I believe that this bill should be limited to primary residences only. People who have to short sale investment properties and second homes should not be the beneficiary of this legislation. If you are a real estate investor and have to short sale some investment properties you simply made bad investments and should not be entitled to tax breaks because of it. Wall Street investors don’t get special tax breaks when stocks go down - real estate investments should be treated in the same manner.
• It is also unclear to me if the indebtedness incurred via cash out refinances would be included or excluded in this legislation. It appears as though cash out refinances that were used to improve the property would be included; but any other use of cash out would not be included. I think this needs to be crystal clear. I believe that cash out refinances that were not used to improve the property should not be included in this relief. Cashing out your home equity is a decision that you as a home owner make and need to understand the repayment ramifications that you incur when borrowing a large amount of money. Borrowing against your home value is not free cash.

What are your thoughts on the new legislation?

Share This