If you are like most homeowners struggling to keep up with your mortgage payments, you are looking for ways to lower the payment.
If that doesn’t work, and someone owes much more than the house is now worth, people then look to give the house back to the bank, by way of a short sale (selling the house for less than what’s owed to the bank) or a “Deed in Lieu of Foreclosure” (giving the house back to the bank instead of having the bank go through foreclosure).
In both situations, the homeowner is looking to have the bank forgive the rest of the mortgage debt. But, with forgiveness of debt comes tax consequences. When the bank or mortgage company forgives the debt (states that the homeowner doesn’t have to pay it), they are required to issue a 1099-C, for “income from cancelled debt”.
And, with the major banks’ settlement with the Federal and State governments, principal reductions (compromising the balance of mortgages) are supposedly on the way also. Note that all of these types of relief are voluntary on the banks’ part.
Before 2007, a homeowner had to report any forgiven debt (from short sale, principal reduction or deed-in-lieu) as income on their Federal Income Tax Return. In 2007, the Mortgage Forgiveness Debt Relief Act allowed debtors to exempt this type of income, and it was extended to the end of 2012.
Without further action from Congress, this important tax exemption will expire at the end of 2012. This could mean that if you, in your good intentions, decide to sell your house short or work with the bank to do a “deed in lieu” of foreclosure, you could still have to pay income taxes on the amount the bank forgives.
See the Chicago Tribune’s recent report on this “hidden time bomb”, about to expire: http://articles.chicagotribune.com/2012-09-20/classified/sc-cons-0920-mortgageaid-taxes-20120920_1_mortgage-debt-principal-reduction-exemption
Many people try to avoid filing bankruptcy by trying to get the house bank to the bank and eliminating the debt in these ways. But it is important to recognize the tax consequences and speak with an experienced attorney to review your best options.
If you have questions about the tax consequences of short sales, mortgage debt forgiveness, or deeds-in-lieu of foreclosure, call us. We have offices in Chicago Loop, Oak Lawn, Skokie, and Waukegan.
Daniel J. Winter
LAW OFFICES OF DANIEL J. WINTER
53 W. Jackson Boulevard
Suite 725
Chicago, IL 60604
312-789-9999
djw@dWinterLaw.com
BankruptcyLawChicago.com
