The housing crisis has many people concerned. Every day thousands of people are losing their homes to foreclosure. But for many people, the problems don’t end there. They must deal with possible tax ramifications.
For those of you who don’t know, the general rule is that debt cancellation is a taxable event for the homeowner. There are a few exceptions, including title 11 bankruptcy, qualified farm debt, bankruptcy, and certain qualified real estate business debts. But these exclusions can be complex, so taxpayers should be very careful when analyzing their situation.
One exclusion under which many taxpayers will find relief is the Mortgage Forgiveness Debt Relief Act (the “Act”) of 2007. This allows qualifying taxpayers to exclude qualified primary residence indebtedness if the balance on the mortgage was less than $2 million ($1 million for a married person filing separately). The Act applies to qualified debt (usually purchase money and/or original purchase debt) at a taxpayer’s principal residence.
If the cancellation of the debt resulted from the disposition of your main residence and you do not qualify under the Act, you may qualify under the insolvency exclusion. The insolvency exclusion is too complex to discuss in depth here, but let’s say that if you don’t have many assets and have substantial liabilities, you may be able to exclude some (if not all) of the debt discharge from income on your tax return. . return.
Another issue that many people may not be aware of is the fact that when a property is foreclosed or sold through a short sale, you must determine if there is any gain or loss on the sale or disposition of the property. People don’t realize that a foreclosure is still a disposition and should be analyzed accordingly. Under certain circumstances, the taxpayer may have a taxable gain even though the property has been seized.
If the debt cancellation relates to a rental or investment property, you should be especially careful. Dealing with tax issues associated with rental or investment property can be very challenging, which is why you should seek the help of a professional.
Taxpayers should realize that analyzing the tax impact of debt cancellation is complex and should seek the guidance and advice of a CPA or other qualified tax professional for any issues they may have. Not only may they have a tax bill, but they also need to make sure that all the forms required by the IRS are properly completed.
