mortgage forgiveness

Advice on Mortgage Forgiveness

A decade ago, some homeowners lost their homes to foreclosure or set up a short sale to get out from under the debt during the mortgage meltdown that caused the Great Recession. Lenders forgave all or part of the debt owed them in most cases.

Again, in the early ’90s we had the Savings & Loans failure in the U.S., and thousands of homeowners lost their homes in the same way. Back then the IRS policy was to consider the forgiven debt as income. Today, it is still considered income. A homeowner could lose their home because they cannot pay for it and they would owe income tax on the relieved debt.

Good News

In late 2007, Congress passed the Mortgage Forgiveness Act. This Act has continued to be extended with a current expiration of 12/31/2020.

The amount that is forgiven on your income tax may not be the same amount you owe your lender. Mortgage forgiveness is for your principal residence only; it does not include investment properties or second homes. Only the amount of mortgage debt that can be treated as acquisition indebtedness is included.

I have provided you an example below where a homeowner purchased a home and refinanced the home five years later at 80% of the market value.  The new loan proceeds were used to pay off the original mortgage and make $30,000 of new capital improvements.  The revised acquisition debt is the acquisition debt at the time of refinancing plus the capital improvements made with the loan proceeds.

The new $400,000 loan produced $39,417 of home equity debt which is not considered acquisition debt.  Home equity debt is money borrowed on a home and can be used for any purpose, but it may not be tax-deductible or considered acquisition debt.  Acquisition debt is money borrowed to buy, build, or improve a principal residence subject to a $750,000 limit.

Assume that the borrower never made a payment on the new loan.   If the new loan went through foreclosure while the Mortgage Forgiveness Relief Act is in effect, the forgiveness would be limited to the acquisition debt of $360,583 and the remaining amount of $39,417 would be considered income and subject to tax.

By providing this content, I mean to inform you of the liabilities associated with foreclosures and the possible remedies that may be available.  My example is meant to illustrate the portion of a loan that could be forgiven.  You should always consult with your tax professional regarding your specific situation and the way the current law would apply to you. For more information, consult IRS Publication 4681.​

Example
Purchase Price … 5 years ago $400,000
Mortgage at the time of purchase … Acquisition Debt $360,000
Fair Market Value … Today, 5 years later $500,000
Refinanced 80% – Loan to Value $400,000
Replaced unpaid balance – current acquisition debt $330,583
Capital improvements made with loan proceeds $30,000
Revised acquisition debt $360,583
Home equity debt … the difference in refinanced amount and acquisition debt $39,417

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