Did you know that if you had a real estate foreclosure in 2007, you may not have to pay taxes on any of the forgiven debt? This is new for the 2007 tax year. You see , usually when a house is foreclosed, the bank may not sell the house for enough to pay off the loan. Depending on the circumstances, the lender may “forgive” the homeowner the difference and just zero out the amount that was still owed.
Let me give you an example.
Say you owe $250,000 on your house and you get into trouble and can’t make the payments. Finally, the worst happens and they foreclose on you. I say the worst, because this absolutely destroys your credit for many years, don’t let anyone tell you otherwise. But we know it happens, and it happened a lot more than normal in 2007.
The bank comes in a sells the house at auction for $225,000. Well , technically , you owe the bank the remaining $25,000, and they can pursue you to get that money. But they “may” forgive that $25,000 and call it even. (You should try to get this in writing before you let the house go to foreclosure if you can.) So if they do that, the IRS says you have just made $25,000 of taxable income. Sort of a double whammy at that point, huh?
In 2007, Congress passed some legislation called the Mortgage Debt Forgiveness Act of 2007. This act essentially says for the years 2007, 2008 , and 2009 this rule of taxing this as if it were income does not apply. There are some restrictions, though. The act only applies to debt under 2 million dollars for a married filing jointly ($1 million if filing single) and it only applies to real estate that was a personal residence. It does not apply for second homes, vacation houses, and the like.
The IRS website says “In most cases, eligible homeowners only need to fill out a few lines on Form 982 (specifically, lines 1e, 2 and 10b).” Your lender should have provided you form 1099-C no later than Jan 31, 2008 for tax year 2007. By law, this form must show the amount of debt forgiven and the fair market value of any property that was sold through foreclosure.
In these times of financial downturn, you need all the breaks you can get. Be sure to take this one if you are in this situation. Check out the new tax deduction for PMI that is new this year as well.
As with all my financial or tax advice, I am not advising as a professional and I give no professional legal or tax advice. If you need professional advice, please get that from a CPA or attorney.
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