The IRS Forgives You!

President Bush signed into law today a new measure giving tax breaks to homeowners who have mortgage debt forgiven through a short sale or foreclosure. The current law states that the debt forgiven by a lender, such as for short sales and foreclosure, were generally taxable to the borrower as debt forgiven income. With the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer does not have to pay federal income tax on debt forgiven for a loan secured by a qualified principal residence.

This tax break applies to debts forgiven from January 1, 2007 to December 31, 2009. Qualified principal residence indebtedness is debt incurred through acquiring, constructing, or substantially improving the residence (up to $2 million for refinances).

For purposes of calculating capital gains, any debts forgiven excluded from income under the new law must be subtracted from the basis of the taxpayer's principal residence (but not below zero). However, taxpayers may generally exclude from capital gains income up to $250,000 (or $500,000 for married couples filing jointly) for properties owned and used as their principal residence for at least two of the last five years.

This is great news for the wave of homeowners who are facing a short sale or foreclosure because of the credit crisis. However there are other issues to deal with if this loan is a FHA or VA loan. With FHA loans you will never be able to obtain another FHA loan again unless you pay back the loss on you loan. With a VA loan you will never be able to obtain another VA loan again and you will loose ALL of your VA benefits unless you pay back the loss on your VA loan. The Good News Is! The IRS Forgives You!