Congress extended the Mortgage Forgiveness Debt Relief Act of 2007. This Act was due to end December 31st of 2012 and now is extended through the end of 2013.
What does this mean for troubled homeowners who wish to complete a short sale in 2013? Let's look at this hypothetical example below:
A family owns their home and then due to difficult times, can no longer afford to
pay and stay in the home. They also can't sell the home at market value because
they purchased in 2008 for $700K, at the height of the market. By mid
2012, the home is now worth $550K. The family applies for a short sale with
their bank, so to avoid foreclosure. The bank clearly sees the hardship of this
family and agrees to allow them to sell the home as an approved short sale for
$150K less than the loan amount, thus avoiding foreclosure.
Prior to the act, the IRS looked at the forgiven debt as taxable income. With the extension of this Act through 2013, this family will not owe taxes on the $150k difference that the bank took as a loss.
What will happen if the Act does not get extended again into 2014?
If Congress does not extend this Act, and the above scenario happens in 2014, then the IRS would see the $150k as taxable income. In a 25 percent tax bracket, that is $37,500 the homeowner is responsible in paying the IRS.
This Act benefits qualified homeowners through 2013, who may have otherwise owed taxes on the bank forgiven debt after closing escrow on a short sale.
Please note I am not a tax advisor and that homeowners need to make sure to always consult their tax advisor.