Foreclosure may be Taxable for Many

Written by Peter Tran

June 29, 2017

As we transverse the calendar from 2012 to 2013, the horizon is veiled in a fog of financial uncertainty.  If we do not steer clear of this proverbial fiscal cliff, the average taxpayer will face a major tax increase as the Bush Era tax cuts expire.  The Adoption Credit will disappear for most adoptive parents.  […]

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As we transverse calendar from 2012 to 2013, horizon is veiled in a fog of financial uncertainty.  If we do not steer clear of this proverbial fiscal cliff, average taxpayer will face a major tax increase as Bush Era tax cuts expire.  Adoption Credit will disear for most adoptive parents.  Changes in Standard Deduction will resurrect marriage tax Dependant Credit and Education Credits will be slashed as Child Tax Credit is cut in half.  As uncertain as se skies may seem, however, under homeowners (debt on ir home exceeds its value) facing pect of short-sale and/or foreclosure may soon face anor dilemma: a sea of tax debt d by expiration of Qualified Principal Residence Indebtedness Exclusion. 

Qualified Principal Residence Indebtedness Exclusion was created by Mortgage Debt Relief Act of 2007.  exclusion was scheduled to expire in 2009 but was extended through 2012 by Emergency Economic Stabilization Act of 2008.  Qualified Principal Residence Indebtedness Exclusions (QPRIE) allows homeowners to exclude up to $2 million dollars of cancelled debt (reported via Form 1099-C) from taxable income.  To qualify debt must have been secured by ir principal residence.  It must have also been acquisition debt (used to build, buy, or improve property).  This QPRIE has saved countless thousands of housing bubble buyers countless millions in taxes.  Currently, re are at least six bills in Congress that will extend QPRIE through 2013.  Unfortunately, however, only one, Senate Bill 3521: Family and Business Tax Cut Certainty Act, has made it out of committee as of time of this writing.  If exclusion is not extended, homeowners will have to pay tax on cancelled acquisition debt unless y are insolvent (via Insolvency Exclusion) or have had debt discharged in kruptcy.

Financial + Tax Trauma: Imagine losing your home be you cannot afford to make your payments. n, as if this trauma were not enough, you receive kick in gut: a huge tax bill be k cancelled remainder of a debt you were too broke to pay.  For example: Consider John who owes $300,000 on his primary residence.  He purchased home at top of housing bubble and today its value is $185,000.  If Qualified Principal Residence Indebtedness Exclusion is not extended and John’s home is foreclosed upon or sold-short for $185,000, remaining $115,000 debt may be taxable to John if k forgives it and he does not qualify for one of two or cancelled-debt exclusions: insolvency and kruptcy.

If John was not insolvent (meaning his total s are greater than ir total liabilities) just prior to debt’s cancellation and/or debt was not discharged in kruptcy, he will owe tax on cancelled debt.  How much tax?  John will receive a Form 1099-C for $115,000 from his mortgage company which he will have to add to his taxable income on his 2013 income .  John will owe over $35,000 in additional federal and state taxes (assuming a federal and state tax rate of 25% and 6% respectively).  And did I mention, or than having a relatively small retirement nest-egg, John is broke.  To pay tax, John will probably have to remove money from his retirement account, creating anor taxable event plus a 10% if John is under age 59 ½.

Will Exclusion be extended?  As stated earlier, re are currently at least half-a-dozen congressional bills that will extend this QPRIE through 2013.  One of se bills may become part of fiscal-cliff legislation or it could be passed in 2013 and made retroactive.  se possibilities, however, provide little solace for under- homeowners who are financially pressed to make a decision.  For those seeking certainty, your best option may be contacting your congressional representatives.

This article (or any article) should not be relied upon to make tax or financial decisions.  If you have questions regarding assistance regarding taxation a particular tax issue or have a question regarding how Health Reform may impact you and/or your business’s tax obligations, please feel free to contact our office to consult with a tax professional.

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