I recently learned that some people (that I personally know) were not aware that they could owe income tax on their unpaid mortgage debt after foreclosure or short sale.
They thought — understandably — that once the house was gone, the whole unhappy mess would be over and done with.
Is this you, too?
The IRS considers cancelled or forgiven debt to be “income.” I know, way to go, IRS. Kick a man when he’s already down.
Fortunately, in 2007 the US Congress passed the Mortgage Debt Relief Act of 2007, and it was afterward extended to December 31, 2012. (See these IRS references for more specifics: The Mortgage Forgiveness Debt Relief Act and Debt Cancellation and Mortgage Debt Forgiveness: 10 Key Points.)
What this means is that if you are underwater on your mortgage and struggling with your house payments, if your house is not sold or foreclosed on by the end of this year, you will most likely be hit with a tax bill for the unpaid balance at some point in the future.
If you are currently unable to make your mortgage payments and your lender has started to make noises about foreclosure, it could still take the lender a year or even much longer to finalize the foreclosure through the court system. But if you go that route you will miss out on the opportunity offered by the Mortgage Debt Relief Act.
That sure is the definition of adding insult to injury. On top of losing your home — typically a stressful and upsetting experience — you will owe taxes on the unpaid balance of your home loan.
Here’s an actual example:
|Clearwater house purchased for $259,900 in June 2006, first mortgage amount was||$230,000|
|Second mortgage taken out in July 2006 for||+ $80,000|
|Total owed on property was||$310,000|
|Property short sold in March 2011 for||– $130,000|
|Total unpaid debt on property was||$180,000|
OMG! Can you imagine being responsible for taxes on an additional $180,000, in one year? Fortunately for the sellers, the Mortgage Debt Relief Act applied and they were spared this additional hit.
Before you sink into complete despair, the game isn’t over. It is entirely doable to get your home short sold before the end of this year. But there is no time to lose — you have just a bit over seven months to get your house on the market for a short sale, under contract and closed. Although many lenders have sped up their processing of short sale offers, it is not a slam dunk. You do need to start right now.
It is hard to believe anyone in this situation would not choose the short sale path. Happily, my friends have now seen the light. And none too soon.
If you have questions about short selling your home, give me a call at 727.286.1249.Google+