East Bay Blog

The holiday weekend is almost upon us, and with that the “official” start of summer. I appreciate you taking the time to come back to the East Bay Real Estate Blog, and if it is your first time then welcome. I wanted to make sure to get my update in today, because tomorrow will be busy, and the Friday before a three day weekend is always a tough time to try to sit down and write intelligently.

Today I thought it would be interesting to write about a tax law that I think will take more and more people by surprise in the coming year. Anyone that is going through a foreclosure or short sale and is paying their lender less than what is owed will be hit by this tax. Now let me back up for a second, for those of you who are not familiar with a short sale, it is when you sell a house for less than what is owed, and the lender agrees to “forgive” the difference between what is owed and what they will actually get. This happens when the loans on a property exceed what the property is worth. In a foreclosure, the lender simply takes the house back from the owner for non-payment.

So this tax law says that when personal debts are canceled by a creditor, the amount forgiven is treated as ordinary income unless the taxpayer is insolvent or bankrupt. Worse yet, the lender is required by law to report the amount cancelled to the IRS. So let’s say that Mr. Seller owes $700,000 on a house, but now the house is only worth $625,000. Mr. Seller decides that instead of paying the mortgage, they will approach the lender and tell them that they must sell that house now, or else they can not pay. So the house is sold for the present market value of $625,000 and the $75,000 difference between what is owed and what the property was sold for is “forgiven” by the lender. The lender is able to get some money out without the expense of foreclosure. Now the lender is required to send the IRS a Form 1099-C showing that Mr. Seller had a $75,000 debt forgiven. Next year at tax time Mr. Seller will be required to pay tax on that $75,000, and it will be taxed at Mr. Sellers ordinary income tax rate, ouch!

Currently there is legislation on Capitol Hill that would soften the impact for these financially stressed homeowners. The Mortgage Cancellation Tax Relief Act of 2007 (HR1876) would amend the tax code to exclude debt forgiveness on principal home mortgages from treatment as income. If this bill passes, it will be welcome news for the thousands of homeowners who are going through short sales today.

If you have any topics you would like me to write about, or an opinion on a previous topic, please don’t hesitate to contact me. Thanks again for stopping by, and have a wonderful Memorial Day Weekend!