New Foreclosure Law - Will it Help?

On December 20, 2007 the President signed the Mortgage Forgiveness Debt Relief Act of 2007.  Although the law will help a very specific group of people, it is hardly a cure for what ails many homeowners across America. 

Homeowners who undergo foreclosure or a short sale often face a tax bill on the difference between what they owed, and what the mortgage lender received for their home.  For example:  You have a loan for $300,000, but your house is only worth $275,000.  You sell the house for $275,000 and the lender forgives the remaining $25,000.  However, many homeowners receive a 1099 from the lender at tax time for that $25,000, meaning that the homeowner is being taxed for an additional $25,000 of income. 

Under the new law, from Jan. 1 2007 through Jan. 1, 2010, certain discharges of mortgage debt on a principal residence will be excluded from the taxpayers gross income.

So what are the catches that impact the effectiveness of this new law? 

1. The amount of indebtedness is capped at $2 million.
2. the discharged debt must be acquisition debt (must be from a mortgage used to purchase the home, refinances are not eligible.  Example:  You bought your house for $200,000 and now you have refinanced your loan up to $350,000.  You sell for $300,000 and are granted a short sale by the lender.  This debt would be taxed.  If your neighbor bought his house for $350,000 and sold for $300,000, his debt would not be taxed because it was "acquisition debt."
3. Must be principal residence

The law will also apply to situations where a borrower and lender have come to an agreement to "restructure" the loan and the loan balance has been reduced as part of the agreement.

Homeowners who completed a short sale or experienced a foreclosure last year are out of luck under the new law as well.

As I said, the law is much needed.  It is ridiculous to tax people on income they never received.  More importantly, a person would not go through the process of a short sale or foreclosure if they had the money needed to pay those taxes!  It is unfortunate the law is so situation specific, but that is how politics must work to get things done.