using calculator

Short-sale and principal reduction tax break may expire

The housing market's decline may have affected a lot of Arizona homeowners as they faced the threat of foreclosure and their mortgage payments became higher than the market value of their homes. With income declining and mortgage payments increasing, struggling homeowners may have filed for personal bankruptcy to retain ownership over their house and other assets.

Chapter 7 bankruptcy filers may be able to keep their car, home and other household items, depending on their monetary value. For many, this was the solution to their problems as they regained control of their financial lives in difficult economic times.

Other homeowners may have sold their house in a short sale--selling the property for less than the amount still owed on it. Homeowners who availed this opportunity may have been hoping to become eligible for the tax break given to those with 'forgiven debt.'

Previously, when a lender reduced the amount owed on the mortgage or if a homeowner sold their property for less than the amount due on their mortgage, the amount reduced or left over was treated as income that would be taxable income for state and federal taxes. After the housing crisis, this 'forgiven debt' was made nontaxable under both federal and state tax law.

The Mortgage Forgiveness Debt Relief Act was enacted by Congress in 2007 to help struggling homeowners. However, it is set to expire at the end of this year and it is not yet certain whether it will be extended.

Not all homeowners are covered by the Act--only original mortgages used to purchase the home and refinancing to improve the home are eligible. If refinancing was not used to improve the home, any forgiven debt on the mortgage may still be taxable.

Homeowners hang in the balance until Congress decides whether to extend this tax break. According to some analysts, many homeowners will be affected by the final decision.

While Arizona homeowners wait to see what Congress decides, they should keep in mind that filing for bankruptcy generally does not discharge taxes, with rare exceptions.

Source: San Francisco Chronicle, "Clock ticking on forgiven-debt tax break," Carolyn Said, Sept. 17, 2012