Can you imagine paying taxes on "Income" You never actually had? What? That's Right. Loan Forgivenessby a lender may not be exactly what most homeowners, already troubled with late fees, delinquencies, foreclosures,short sales, or deed in lieu of foreclosure.
A homeowner, who experiences a major life change, medical bills, unexpected loss of job, or death of a loved one. Suddenly he is unable to make mortgage payments. He contacts his lender, works out a deal and in some cases (short sale) or other arrangement whereby the bank forgives part of the debt. Done right? Not exactly.
The lender will report the forgiven portion of the debt 1099-C form. The IRS can calculate taxes against the homeowner as "Ordinary Income" the following year. Say a short sale creates a $40,000 deficiency. The bank accepts the offer. The deal closes. The following year the seller may be charged for Federal Income Tax due on the $40,000 the bank forgave.
There is a new proposal currently on the floor in Capitol Hill. The Mortgage Cancellation Tax Relief Act of 2007.Sponsored by Reps.Robert E. Andrews (D-NJ) and Ron Lewis (R-Ky). The bill would effectively allow lenders to renegotiate delinquent mortgages without penalizing borrowers the following year. The bill is currently under consideration by the House Ways and Means Committee. Should the bill pass, debt forgiveness would not be taxed as income.
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