THE MORTGAGE FORGIVENESS DEBT RELIEF ACT OF 2007
FROM: Jeff Waldron ‐ Attorney Email: JeffWaldron@DavisBrownLaw.com Phone: (515) 246‐7802 DATE: January 16, 2008 In response to the subprime lending crisis, the President recently signed into law a new measure that will make it easier for a homeowner to refinance or to sell their home on a short sale. A short sale is typically an option where a homeowner owes more on a mortgage loan than the home is worth. If the lender agrees to allow the homeowner to sell on a short sale, the homeowner can sell the home at a loss, and the lender will forgive the remaining debt. For example, assume a borrower owes $300,000 in acquisition debt secured by the borrower’s principal residence, and the lender agrees to allow the borrower to sell the home on a short sale. Borrower then sells the home for $250,000, and, as agreed, the lender forgives the remaining $50,000 of debt. Under preexisting law, debt forgiven by a lender was considered income to the borrower, which was generally subject to taxation. Thus, in the above example, the borrower would have to come up with thousands of dollars in cash to pay income tax on the $50,000 of debt forgiven. The Mortgage Forgiveness Debt Relief Act of 2007 gives tax relief to a borrower by excluding this forgiven debt from income. In the above example, the borrower would no longer be required to pay tax on the $50,000 of debt discharge income. DETAILS OF THE ACT • This tax change applies only to debts discharged from January 1, 2007 to December 31, 2009. • The tax relief applies to up to $2 million of debt forgiven for a loan secured by a qualified principal residence. It doesn’t apply to discharges of second mortgages or home equity loans, unless the loan proceeds were used to acquire, construct, or substantially improve the taxpayer’s principal residence. • The indebtedness must be incurred with respect to the taxpayer’s principal
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residence only. The tax basis of the individual’s principal residence is reduced by the amount excluded from income. For example, if the taxpayer initially paid $200,000 for the house, there is likely a $200,000 tax basis in the house. If $50,000 of debt is discharged by the lender, the tax basis will be reduced to $150,000.
This is only a summary of this tax relief provision. Contact a tax professional if you would like more details about this change.