The Mortgage Debt Relief Act of 2007 was enacted as a response to the growing foreclosure problem. More specifically, it addresses the issue of “Debt Forgiveness Income.” Debt Forgiveness Income is an IRS theory that if a debt you owe is forgiven, you have gained in monetary value because you no longer are required to pay that debt. That gain in value is taxable as income despite the fact that you didn’t actually earn any money. For example: Stephen owes $5,000 in old medical bills. He can’t pay the bills, so the hospital forgives the debt and writes it off on their taxes. Come tax time, he will receive a Form 1099 for $5,000 of additional, previously untaxed, income for that year. Now, $5,000 may not be too much of a problem, even in the highest tax bracket this would only increase his taxes by $1,750, the trouble starts when the amount forgiven is higher, as it is with a house.
If Stephen’s home is foreclosed upon and the bank forgives a $50,000 debt, he will owe taxes for his actual annual income, plus this $50,000. You could’ve argued that $5,000 wouldn’t effect what bracket he was in before, but $50,000 is almost certain to increase his tax bracket and will leave him with a minimum of $12,500 in additional tax debt. As a result, Stephen may be in debt for a long time. If he didn’t have the money to pay his mortgage, it doesn’t make sense that he’d have enough money to pay the taxes.
It was because of Stephen’s scenario that the Mortgage Debt Relief Act of 2007 was passed. The act allows a person whose homestead has been foreclosed on to have his debt forgiveness income waived so long as it is less than a million dollars per year.
This waiver is set to expire by January 1, 2013, which has some economists worrying. Personally, I think these economist’s concerns are without merit. The original act of 2007 was set to expire in 2009. When 2009 rolled around, Congress could see that there was still a problem and passed the Emergency Economic Stabilization Act of 2008, which extended the tax waiver until 2013. So, as gloomy as our housing economy is, I cannot fathom that Congress will not pass another act extending the homestead foreclosure tax waiver, but if they do, the debtors can always file bankruptcy and discharge the debt before it becomes a tax liability.
If your home is in foreclosure and you have questions about your future or the tax implications forthcoming, contact a Jacksonville Bankruptcy Attorney or call us at (904) 685-1200 for a free consultation.