This is great news for homeowners who are considering a short sale on their principal residences, or for those who are requesting a waiver of the deficiency balance on the loan. Generally, if a bank lends you money to purchase your home, and the bank later cancels or forgives the debt balance, you may have to include the cancelled balance as income for tax purposes. The Mortgage Forgiveness Debt Relief Act allows a homeowner to exclude this amount, which saves a homeowner thousands of dollars in tax liability.
For example, if a homeowner owes $100,000 on a home, and the homeowner and the bank agree to a short sale on the property for $75,000, there is $25,000 in principal balance left over. Without the Mortgage Debt Relief Act, the homeowner would have to pay federal taxes on the $25,000 balance, because the government would consider the $25,000 “earned income.” Because the Act is in place for 2013, the tax debt owed by the Homeowner will be waived, if the closing takes place in 2013. This also applies if the homeowner and bank come to some agreement where the deficiency balance is waived for other considerations, such as a stipulated foreclosure judgment. If you are considering a short sale of your principal residence or are currently involved in a foreclosure lawsuit, it will be beneficial to have it resolved this year so that you can take advantage of this Act before it expires.