Home Foreclosure and Debt Cancellation
Dear Family Law Lawyer: My wife and I are getting divorced. Late last year, I was laid-off from my job as a construction contractor. It was our only source of income. Once I was laid-off, we couldn’t afford to make our mortgage payment. Our house is now in foreclosure. It is also “underwater” – we owe more on it than it is actually worth. Someone told me that if we don’t pay the difference between the amount of the loan and the fair market value of the home, we could end up owing taxes on the difference. Is that right? We can’t afford to owe money to the IRS. Tom in St. Michael, Minnesota.
Dear Tom: You need to talk to an accountant. It may be possible to avoid potential tax liability, depending upon your circumstances. While I am not an accountant or a tax lawyer, I can give you some basic information about the law.
Generally, if a creditor discharges or agrees not to collect money from someone who owes it to them, the money that has been discharged or written-off is considered income to the person who benefits from the transaction. For example, if you owe a credit card company $30,000 and the company agrees to take $20,000 in full satisfaction of the debt, you are deemed to have income (and thereby potential tax liability) on the $10,000 that was forgiven. There are, of course, exceptions to this rule, the most common being debt discharged in connection with a bankruptcy. See 26 U.S.C. § 108.
Until recently, a similar analysis was applied in the home foreclosure context. If you had debt forgiven through a foreclosure – which usually occurred when a lender decided not to pursue a deficiency judgment against a borrower who owed more than their house was worth – you might have added income for tax purposes. But, effective December 11, 2008, Congress changed the law. In the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers are now allowed to exclude income from the discharge of debt on their principal residence, subject to certain qualifications. It can be a completed issue. Please be sure to check with your accountant.
Dear Tom: You need to talk to an accountant. It may be possible to avoid potential tax liability, depending upon your circumstances. While I am not an accountant or a tax lawyer, I can give you some basic information about the law.
Generally, if a creditor discharges or agrees not to collect money from someone who owes it to them, the money that has been discharged or written-off is considered income to the person who benefits from the transaction. For example, if you owe a credit card company $30,000 and the company agrees to take $20,000 in full satisfaction of the debt, you are deemed to have income (and thereby potential tax liability) on the $10,000 that was forgiven. There are, of course, exceptions to this rule, the most common being debt discharged in connection with a bankruptcy. See 26 U.S.C. § 108.
Until recently, a similar analysis was applied in the home foreclosure context. If you had debt forgiven through a foreclosure – which usually occurred when a lender decided not to pursue a deficiency judgment against a borrower who owed more than their house was worth – you might have added income for tax purposes. But, effective December 11, 2008, Congress changed the law. In the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers are now allowed to exclude income from the discharge of debt on their principal residence, subject to certain qualifications. It can be a completed issue. Please be sure to check with your accountant.
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