Ordinarily and generally speaking, if a bank relieves a taxpayer of mortgage debt (through a short sale or deficiency waiver for example), the Internal Revenue Code (“IRC”) requires the taxpayer to report the cancelled or forgiven debt amount as taxable income (subject to any applicable exceptions or exclusions). This is commonly referred to as “cancellation of debt” or “discharge of indebtedness” income. Therefore, even though the taxpayer never actually realizes the forgiven debt as disposable income that year, the IRC holds the taxpayer liable for the appropriate tax amount based on the forgiven or cancelled debt. See Section 108 of the IRC.
In 2007, roughly 11% of American homes were valued at an amount less than the remaining mortgage homeowners held on those same homes. In response to the American housing market recession of the mid-2000’s, Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007. The Act was an immediate effort to alleviate some of the economic hardships facing millions of Americans. For six years under the Act, forgiven or cancelled mortgage debt was not considered taxable income to taxpayers in most circumstances. While America’s economic issues and housing problems steadily trend in the right direction, roughly 6% of American homes remain valued at less than the homeowner’s remaining mortgage on the same.
As of January 1, 2014, the Mortgage Forgiveness Debt Relief Act of 2007 has expired and has yet to be extended by Congress. This means that individuals are again liable for taxes on the sum of any cancelled or forgiven mortgage debt as if the individual realized the amount as ordinary income (absent any applicable exceptions or exclusions). By this time in 2013, the Act had already been extended for that year. While there are proponents to the Act’s extension through as far as 2015, both Congress and the Senate have yet to act on the issue for 2014. Such inaction leads many homeowners to believe that the IRC benefit, extended to taxpayers for six years through the Mortgage Forgiveness Debt Relief Act of 2007, may not be renewed. For now, the homeowner in 2014 whose debt is cancelled or forgiven may have to report and pay taxes on that amount to the IRS.