Think Twice Before Walking Away From Your Mortgage
Thinking about walking away from your mortgage? You may want to think twice - particularly if it is a second home or you have refinanced it.
Many owners think that they can walk away from a mortgage and, aside from a ding to their credit, it is the lender's problem. Well, it's not quite that simple.
The IRS is likely to tax you for the difference between what is owed on the mortgage and the market value of the home, whether it is sold at auction, as a short sale (prior to foreclosure) or when relisted as a bank-owned property, as taxable income. The lender will issue a 1099-C to the homeowner for this amount, which must then be treated as ordinary income on the homeowner's next tax return. In most cases, the sale price of the home will be considered to be the market value. In some cases, the market value of the home will be reported as a higher amount than the actual sales price.
So if your home sells for $500,000 and you owe $600,000, you'll have $100,000 of additional income to report on your next tax return under current IRS rules. That would equate to a whopping $28,000 income tax bill if you're in the 28% tax bracket.
Many are hoping that the proposed "Mortgage Forgiveness Debt Relief Act of 2007", or H.R. 3648, will provide relief from this tax. However, if approved as currently stated, the relief will only be for homeowners who meet certain requirements. H.R. 3648 is meant for principal residences (not second homes or investment properties) and also only applies to the initial mortgages, not refi's. H.R. 3648 defines Qualified Principal Residence Indebtedness (or debt relief to be excluded from income tax) as follows: "For purposes of this section, the term 'qualified principal residence indebtedness' means acquisition indebtedness." In plain English, acquisition indebtedness is limited to the initial mortgage on the property when it was purchased, not a second (or third) mortgage that was acquired later, and not a refinance of the initial mortgage(s).
Certainly it is worth the time to consult a knowledgeable Realtor or tax specialist before taking a step you may regret.
Many owners think that they can walk away from a mortgage and, aside from a ding to their credit, it is the lender's problem. Well, it's not quite that simple.
The IRS is likely to tax you for the difference between what is owed on the mortgage and the market value of the home, whether it is sold at auction, as a short sale (prior to foreclosure) or when relisted as a bank-owned property, as taxable income. The lender will issue a 1099-C to the homeowner for this amount, which must then be treated as ordinary income on the homeowner's next tax return. In most cases, the sale price of the home will be considered to be the market value. In some cases, the market value of the home will be reported as a higher amount than the actual sales price.
So if your home sells for $500,000 and you owe $600,000, you'll have $100,000 of additional income to report on your next tax return under current IRS rules. That would equate to a whopping $28,000 income tax bill if you're in the 28% tax bracket.
Many are hoping that the proposed "Mortgage Forgiveness Debt Relief Act of 2007", or H.R. 3648, will provide relief from this tax. However, if approved as currently stated, the relief will only be for homeowners who meet certain requirements. H.R. 3648 is meant for principal residences (not second homes or investment properties) and also only applies to the initial mortgages, not refi's. H.R. 3648 defines Qualified Principal Residence Indebtedness (or debt relief to be excluded from income tax) as follows: "For purposes of this section, the term 'qualified principal residence indebtedness' means acquisition indebtedness." In plain English, acquisition indebtedness is limited to the initial mortgage on the property when it was purchased, not a second (or third) mortgage that was acquired later, and not a refinance of the initial mortgage(s).
Certainly it is worth the time to consult a knowledgeable Realtor or tax specialist before taking a step you may regret.
posted by Paul S. Lewis at 11:42 AM
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