On January 1, 2013, Congress extended the Mortgage Forgiveness Debt Relief Act, or MFDRA, as part of a tax bill designed to address the so-called “fiscal cliff.”
First introduced back in 2007, the MFDRA was supposed to expire on December 31, 2012, but the new bill extends it through midnight on December 31, 2013. This means that the act now applies to any mortgage debt that was forgiven between January 1, 2007 and December 31, 2013.
The Mortgage Forgiveness Debt Relief Act exempts distressed homeowners from paying taxes on any debt forgiven with a loan modification, short sale or foreclosure. This allows homeowners with underwater properties to look for alternatives to foreclosure, such as loan modifications or short sales, without the added stress of owing several thousands of dollars in taxes.
Before the MFDRA passed, financially strapped homeowners often negotiated a loan modification or avoided foreclosure with a short sale, just to discover they owed a huge tax debt afterwards. This act, which is often referred to as the “Debt Forgiveness Act,” relieves them of that tax obligation because the forgiven debt is no longer considered as income.
Qualified Principal Residence
The Mortgage Forgiveness Debt Relief Act allows homeowners to exclude any canceled debt from being taxed as income but only if the debt was incurred on the owner`s “qualified principal residence.” It doesn`t give you any tax relief for business properties, second homes or investment properties.
The act only applies to canceled or forgiven debts on loans used for buying, substantially improving or building your principal residence. Additionally, the debt must be secured by the principal residence.
The good news is that even debts incurred because of refinancing should qualify but only up to the principal amount of your original mortgage.
You can only count up to two million dollars as a qualified principal debt if you and your spouse file jointly. The limit is one million dollars if you are married but filing separately.
Not every state recognizes the MFDRA, however. Several recourse states require their underwater property owners to find other kinds of tax exemptions, prove insolvency or file for bankruptcy in order to prevent taxation after a short sale. Consult with a tax professional or a licensed attorney before committing to a short sale if you live in a recourse state.
If you have a mortgage debt that was forgiven, the lender is required to send you a Form 1099-C, or a Cancellation of Debt, statement at the end of the year. This form must show the total amount of forgiven debt as well as the fair market value if the property was foreclosed. Notify your lender promptly if the information on the form is not correct.
Those who qualify for debt forgiveness must claim the special inclusion by filling out IRS Form 982, which is called Reduction of Tax Attributes Due to Discharge of Indebtedness. Attach the filled-out form to the federal income tax return for the year in which the qualified debt was actually forgiven.
Increase in Short Sales
Many financial pundits believe that the MFDRA extension is crucial for helping America`s housing industry recover. The federal government is letting the homeowners, real estate professionals and mortgage lenders know that short sales are preferable to foreclosures. Fewer foreclosures should help stabilize the purchase price of homes and lead to a healthier housing market.
The MFDRA offers debt help to struggling homeowners. If you are financially stressed or own underwater property, you have until the end of 2013 to take advantage of this act.