Dennis' Mortgage Blog

Great question Friday from Mark & Chris (Armendariz, great real estate agents and excellent neighbors!) about the Mortgage Forgiveness Debt Relief Act of 2007.  The Act excludes from income taxes debt relief from a lender through short sale.  Essentially prior to the Act if you owed $200,000 on your home and it was sold at short sale for $180,000 then the lender would issue a 1099 to you for $20,000 which would be taxable income. 

Mark & Chris' question was does this Act apply to all mortgages: purchases, rate and term refinances and cash out refinances.  The answer NO!

Under the terms of the law the debt must be "acquisition debt", meaning funds used to purchase the property.  What is not spelled out but meaningful is if the mortgage being discounted through short sale was a rate and term refinance of a purchase mortgage; i.e. you had a $200,000 mortgage balance from the purchase of your home and refinanced to lower the payments, exit an Adjustable Rate, or some other reason but did not obtain cash out of the property.  I would argue that this is still the funds used to acquire the property and since it was not used to pull equity/cash from the property then the Act should apply.  I would argue that but it would be subject to ruling by IRS or other government agency so check with a tax professional or attorney if this may apply to you or a client.

What is not covered are mortgages that were cash-out refinances; i.e. you had a mortgage with a balance of $200,000 and refinanced for $300,000 pulling $100,000 in equity out of the property and then it was sold with a discounted balance to $250,000 you would receive a 1099 for $50,000.

There are several aspects to the bill beyond what I have written here.  Here are two links that may assist you:

1) Duane Gomer has a good recap here

2) If you have the guts to slog through it the text of the bill is here 

Thanks for the question Mark & Chris!

Dennis

 Wednesday, January 09, 2008