What is the Mortgage Debt Relief Act of 2007?

Bush Signs Mortgage Forgiveness Debt Relief Act Of 2007If You own Real Estate in San Diego and have had any mortgage debt forgiven by a Lender through a Short Sale or Foreclosure, the Mortgage Debt Relief Act of 2007  could be very beneficial to your wallet.  However, there are a lot of people who need help that got left out of this legislation…

The Mortgage Debt Relief Act generally allows taxpayers to exclude cancellation of debt tax liability caused by the discharge of debt on a principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. So, the general idea is, if you did a Short Sale or Foreclosure, and the Bank(s) decided to forgive the additional debt owed, then you’d walk away Scott-Free.  Prior to this Act, You would have owed income taxes on the amount forgiven as it would have been treated like “ordinary income”.  Crazy right? You have to pay taxes as if You MADE that money, when You never saw a dime?  RIDICULOUS!

This provision ONLY applies to debt forgiven in the calendar years of 2007 through 2012, but has been extended through 2013. You are eligible for up to $2 million of forgiven debt with this exclusion ($1 million if married and filing separately). The debt which is forgiven must be Qualified Principal Residence Indebtedness (QPRI) in order to qualify.  QPRI is any mortgage obtained to buy, build or substantially improve a primary residence.  It also includes any mortgage resulting from a refinance of a previous mortgage used to buy, build or substantially improve a primary residence, but ONLY up to the amount of the old mortgage principle before the refinancing.

Confused yet? Let’s use an example:

Jane bought Real Estate in San Diego County on January 13th, 2003 for $350,000.  She took out a Loan for $300,000 and put $50,000 as a down payment.  In 2005, she took out a $100,000 2nd Mortgage to add a garage on to the home. By 2008, her mortgages added up to only $325,000.  She refinanced both loans into one loan this time for $400,000 since the Fair Market Value was up to $430,000.  She used the $75,000 extra to pay off credit cards and college tuition for her son.  In 2011, Jane lost her Job, came on hard times and the property value declined significantly.  Her Bank agreed to a Short Sale with a purchase price of $300,000.

In this example, Jane is going to be liable for $75,000 of forgiven debt.  She will owe the IRS as if she had made $75,000 of ordinary income, even though she didn’t make a dime of that money!

Original Purchase Loan – $300,000 = QPRI
2nd Mortgage for Garage – $50,000 = QPRI

Refinance to $400,000 FROM $325,000, so $325,000 is the new QPRI since the extra $75,000 taken out with the most recent mortgage was not used to buy, build or substantially improve the property.  Since the home was sold for $300,000, and her QPRI was $325,000, she gets to use the MDRA to eliminate $25,000 of the total $100,000 in cancellation of debt income, but that still leaves her on the hook for $75,000!

Here are the Problems with the Mortgage Debt Relief Act
– A LOT of people who own Real Estate in San Diego took out a 2nd mortgage for reasons which do not qualify for the Mortgage Debt Relief Act.
– The Mortgage Debt Relief Act only addresses the tax consequences and not the deficient balance consequences. If Jane had foreclosed on her home, for example, and not been exempt from recourse through SB 458, then the Bank would have the option to sue her for the $100,000 OR forgive it (cancel the debt).  They would do whichever would bring in more money, so don’t expect any favors from the Bank.

I know this is really complicated, so if you need help figuring something out, just give me a shout.



Categories: San Diego Real Estate Market, Selling your home, Short Sale, Tax Resolution, The IRS, The Mortgage Debt Relief Act

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