Mortgage Forgiveness Debt Relief Act

The Mortgage Forgiveness Debt Relief Act is scheduled to end on December 31, 2012 and it is possible that it may not get extended. The law, first enacted in 2007, allows homeowners who have received principal reductions on their mortgages as the result of loan modifications, short sales or foreclosures to omit income taxation on the amounts forgiven.

Here’s a little history and how it works. Prior to 2007, all cancellations of debt by creditors (i.e., mortgage, personal or auto) were considered taxable events under the federal tax code. If you owed $500,000, but paid off only $350,000 through an agreement with the lender, the $150,000 difference would be treated as ordinary income and taxed at regular rates. The Act was due to expire on December 31, 2010 however, the deadline extended through 2012. Under this Act, you can omit taxation on forgiven mortgage debt amounts up to $1 million for single filers, and $2 million if married filing jointly. In order to be eligible, the debt must be cancelled by a lender in connection with a mortgage restructuring (i.e. loan modifications), short sales, deed-in-lieu of foreclosure or foreclosure. However, keep in mind that the transaction must be completed no later than Dec. 31, 2012.

When (or if) this tax help expires, it will endanger a great number of distressed homeowners that may have mortgage arrangements in the months (and years) ahead, including those qualifying under the recent $25 billion mortgage settlement. Any borrower, both now and in the future that do successfully receive any principal reduction or debt forgiveness may face hefty and ill-timed taxable income hits in the event this law is not extended.

The clock is ticking and the fast approaching deadline has real estate and tax professionals on edge. Frankly, the bottom line is – if you are thinking about a short sale or foreclosure, it is important that you do it now, do not wait.

And if you are considering a short sale, some benefits to a seller instead of foreclosure might be:

1. An improvement on your credit score….

This is especially true if the short sale is approved while the borrower is current (it can and does happen and is also a significant benefit in terms of ability to get a new home mortgage (in as little as 2 years).

2. If the seller has at least two mortgages.