Don’t Ask for Forgiveness
A popular tax break for those who reduce their mortgage debt is expiring at the end of this year
On January 1, a tax break intended to help struggling mortgage borrowers is set to expire, and the financial repercussions could be major.
The Mortgage Forgiveness Debt Relief Act (MFDRA), signed into law in late 2007, was enacted to offer relief to homeowners who reduce their mortgage debt as a result of a short sale, foreclosure or mortgage restructuring.
Here’s how it works: Whenever a lender cancels or reduces a portion of a debt that is owed by a borrower, the cancelled amount is reported as income for the borrower’s tax purposes. In the case of a mortgage, this can result in a tax bill of tens of thousands of dollars or more. The MFDRA generally offered taxpayers the ability to exclude some of this “income” if it was related to their principal residence.
If this tax break expires, it could be bad news for the 10.7 million American homeowners who are underwater on their mortgages and owe at least 25 percent or more than their home is worth (according to RealtyTrac).
“This will affect anyone completing a short sale, foreclosure or loan modification with principal reduction. No one should count on another extension [of the MFDRA] at this time, and they should be exploring all options to make sure they are properly prepared,” says Glen Henderson, broker at Alliance Group Real Estate Services, San Diego.
Homeowners affected should “talk to an accountant or tax preparer so they can have a thorough understanding of the impact on their personal situation,” says Eloise Brown, associate for Century 21 Christel Realty, Rockaway, N.J. “They also need to consider the impact of a foreclosure on their credit rating and future ability to buy a house.”
Affected homeowners may need to change spending habits, consider elimination and consolidation of other debts and work out a payment plan, Brown adds.
“All of this requires professional guidance,” she says.
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