2017 Might Be an Unforgiving Year
The Burst Bubble
It’s been about ten years since the real estate bubble burst. Many Americans were left owing more on their mortgages than their homes were worth. As many as could do so negotiated mortgage modification plans with their lenders. The result of the modifications, or refinancing, resulted in lower amounts needed to pay off mortgages.
Those homeowners who couldn’t come to an agreement with their lenders suffered through foreclosures or short sales. Unfortunately for them, the value of their homes remained less than the amounts they owed, so they had mortgage payments due unless their lenders were then willing to make modifications.
Modifications meant that people didn’t have to pay back the full amount they had originally borrowed. The lenders “forgave” substantial amounts of what was due. That is debt forgiveness.
The Silver Cloud Had a Dark Lining
Mortgage debt forgiveness allowed people to keep their homes. That was good. However, at the end of the year, they received tax forms telling them that the amount of forgiven debt was taxable income. That was not good.
When money is borrowed, it isn’t taxable income because you agree to pay it back. When you don’t pay it back, it then becomes taxable.
Congress to The Rescue
In 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act. The Act exempted forgiven mortgage debt from taxation. There were some caveats of course. The mortgage had to be for your principal residence. The debt reduction had to be related to a loss in value of your home or changes in your finances.
Forgiven mortgage debt on second homes or rentals was still taxable. If the debt was reduced because you performed work or services for the lender, you lost the exemption. If you had taken out a second on your home and used that money for something else, any debt reduction was taxable income.
The Act has been extended several times. The current extension expired on December 31, 2016. If you began negotiations before then and have a written contract, you may still qualify for the exemption even if the actual forgiveness doesn’t take place until 2017.
The Crystal Ball Is Cloudy
It is unknown at the present time if there will be another extension enacted before the end of 2017. It is also unknown that if such extension would be made retroactive to January 1, 2017.
It’s probably a good idea to contact your representatives in Congress and petition them to extend the Mortgage Forgiveness Debt Relief Act. If you think you’re going to have debt forgiven in 2017, ask Congress to extend the Act retroactive to January 1, 2017.
Neither mortgage lenders nor the IRS is going to forgive debt or taxes just because you say you can’t pay what’s due. There are lots of forms to fill out and hoops to jump through. If you don’t have an attorney or accountant, your first step is to hire one.
Any amount of debt reduction or forgiveness that is not taxed will be subtracted from the tax basis of your home if you sell it. This could have worse financial consequences than paying the taxes at the time your mortgage is reduced. Expert counseling is advisable.
Forms and More Forms
For now, if you had mortgage debt forgiven in 2016, you will receive a Form 1099-C from your lender. It will show the potentially taxable amount. If you disagree with the numbers, you have to contact the lender to resolve any discrepancies.
If you believe you are exempt from taxation, then Form 982 must be attached to your income tax return. Ignoring Form 1099-C is definitely not in your best interests.
Keep in mind also that this is only a Federal exemption. Your state might still consider debt reduction as taxable income.