The Treasury Departments recently announced sub prime mortgage relief plan required legislation for an exclusion of mortgage debt forgiveness from a home owner’s income. Otherwise those homeowners would receive unmanageable income tax debt as discussed in our December BLOG. The centerpiece of this legislation (H.R. 3648) was signed by President Bush on December 20, 2007 and contains a three (3) year exemption for debt forgiveness on qualified home loans. While there were a handful of other real estate benefits in the new law our focus here is the area of Foreclosure Relief.

When a lender forecloses on property, sells the home for less than the borrower’s outstanding mortgage and forgives all or part of the unpaid mortgage debt as in a short sale, the Tax Code considers the canceled debt to be taxable income to the homeowner. The Mortgage Forgiveness Debt Relief Act of 2007 excludes from taxation discharges of up to $2,000,000 of indebtedness that is secured by a principal residence and is incurred in the acquisition, construction or substantial improvement of the principal residence. This special relief is available for the three year period beginning January 1, 2007 and ending December 31, 2009. The provision was made retroactive to January 1, 2007 to help as many homeowners as possible.

Mortgage renegotiations are included in the laws new exemption. When a lender determines that foreclosure is not in the lenders best interest it may offer a mortgage workout where the terms of the mortgage a changed to result in a lower monthly payment. Once such workout plan would forgo adjustable rate resets for up to five (5) years. This and other mortgage forbearance plans technically result in forgiveness of indebtedness that would be taxable to the homeowner if not for this new law.

Specifically the new law applies to qualified principal residence indebtedness which qualified means acquisition indebtedness. This is indebtedness that is incurred in the acquisition, construction or substantial improvement of the principal residence. It also excludes refinancing of such debt to the extent that refinancing does not exceed the amount of the original indebtedness. Homeowners who took advantage of the run up in real estate prices to do “Cash out” refinancing and used the cash to pay off credit card debt, tuition, medical expenses or other expenditures are not covered by the new law exclusion for the cash out amount. That indebtedness is fully taxable unless other exclusions such as insolvency or bankruptcy can be met. The new law does not apply to vacation homes or second residences which a taxpayer may have overextended family finances to purchase. Needless to say it does not cover many speculators who purchased property hoping to take advantage of the rapid appreciation taking place and while using leverage and adjustable rate loans to make “It happen”.

Again, the purpose of this legislation is to shelter homeowners who enter foreclosure or forbearance of debt to become saddled with unmanageable income tax debt.

Keith Webb
CEO