The Mortgage Forgiveness Debt Relief Act is a government bill that offers relief to most homeowners who would normally owe taxes on the forgiven debt after performing a short sale. The Act became law in 2007, and benefits both lenders and borrowers. Under previous US law, when debt is forgiven by a commercial lender (Bank of America, Chase, US Bank etc.), that debt would normally require the borrower to include that amount as taxable income on tax returns. This would normally have caused the borrower to have to pay taxes on their forgiven debt. With this act in place, a borrower DOES NOT have to pay income tax on forgiven debt in most cases.
For example, if the lender forgives $50,000 of debt to the homeowner after the completion of a short sale, under current tax laws that $50,000 is considered income. If your combined federal and state marginal tax rate is 25%, you would then owe $12,500 in taxes. Under the Mortgage Forgiveness Debt Relief Act, you would be allowed to exclude from income the discharge of debt, and therefore not have to pay the taxes associated with it.
The Mortgage Forgiveness Debt Relief Act is applied to debt that is forgiven between 2007 and the set expiration date of December 31, 2012. Since some short sales can take 8 months to a year to complete, it is imperative to talk to a counselor today. The limits of the debt that can avoid tax ramifications is up to $2 million, or $1 million if married but filing separately. The specific purpose of this act is to help homeowners avoid financial hardships by performing a short sale.
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