The act allows you to walk away from a foreclosure free and clear. The bank forgives the potential income you would get with a 1099. It is meant to be used on your primary residence so it will not help an investor with multiple properties.

What does that mean?

When the bank accepts a short sale or sells your property for a loss and sends you a 1099, you are supposed to claim this income on your tax returns. When claiming this as income, the new act allows the debt to be forgiven – meaning you don’t owe taxes on it. This is an amazing statue. There has never been anything quite like it before. So, if you have to loose your house, now is a good time because you can truly start over.

Does the Mortgage Forgiveness Debt Relief Act of 2007 apply to all forgiven or cancelled debts?

No, the act applies to your primary residence only. Again, anyone with multiple properties will not qualify for this exclusion.

What about refinanced homes?

The act applies to properties that have been refinanced with some exceptions. You can only be forgiven the orginal amount of the loan. For example - you have a property where you owed $150,000 dollars and then you refinanced it for $200,000 dollars, pulling out $50,000 dollars profit. Only the original amount of $150,000 dollars would qualify under the new act. If the bank sold the house for $125,000 dollars, $25,000 would be exempt and you could be sent a 1099 for the $50,000 dollars that you pulled out of the house. It is considered profit even though you lost the house to foreclosure.

Does this provision apply for the 2007 tax year only?
Currently, this bill will apply to the 2007, 2008, and 2009 tax year. Once it is reviewed, it might stay in place longer. In the current market, walking away from a house is a solid option because you can be forgiven the debt. In the past, most homeowners suffered a deficiency or a 1099.

If the forgiven debt is excluded from income, do I have to report it on my tax return?
Absolutely. You must report the amount of the debt. As we said earlier, it is important to use a tax accountant to file your taxes the first after a foreclosure or deed in lieu. You will use form 982 and attach it to your tax return.

“Private mortgage insurance” is paid for by the borrowers and made part of their monthly payment. Many homeowners believe that this insurance is a benefit to them in case one of the owners dies during the loan repayment period.

  • PMI insurance is protection for the lender.

When a mortgage goes into default that is insured with PMI, don’t walk away. Follow the same short sale procedure as FHA and VA and see what happens. Unlike FHA and VA, the percentage amount of the PMI insurance paid against the current value can be negotiated, therefore creating a great short sale.

  • PMI only covers the top 20% of the loan. For example, if a property has a $100,000 mortgage balance and it has PMI insurance, in the event of a default, PMI pays the bank just $20,000, the top 20%. If you can get the PMI company to work with you, they don’t have to pay the claim. The claim kicks in at the sheriff’s sale or the final point of default. PMI can be very helpful when faced with a way out of paying a claim.
  • When a property is vacant it is more difficult to get FHA or VA (or any bank for that matter) to accept a short sale. Your defense is to have the homeowner’s explain in their hardship letter that they could not afford the house, could not afford the repairs, did not realize another alternative existed, thought that when they were served the foreclosure papers it meant the bank already owned the property, etc., and that is why they moved. In many cases, this will solve the problem.

That is a good question. When you negotiate a successful short sale, keep in mind that the agreed upon price is payment in full.
  • However, the homeowners may still owe the difference between the mortgage balance and the discounted amount via a “deficiency judgment.”
If granted, this judgment will affect the homeowners and their credit report just as any other judgment. You must get the bank to agree to accept “payment in full without pursuit of any deficiency judgment.”
  • In addition, you need to explain to the homeowners that the discounted amount (the difference between the mortgage balance and the short sale) may be declared as income on their income tax return by means of a “1099.”

The homeowners can speak with their accountant for advice. Since the homeowners have been in such duress and probably haven’t made much income, a 1099 may not adversely affect them.

The best way to deal with a 1099 is to consult a tax accountant and see what can be worked out. In many cases, you might not owe anything. An accountant may be able to file “insolvency” or get a “one-time homeowners exemption” or use your “adjusted basis” for write offs.. If you qualified for any of these, you would be off the hook.

If you suffered loss if income, are going through a divorce, had a mortgage payment that reset to an unaffordable payment, or anything along those lines you may qualify for insolvency. You are considered insolvent when your total liabilities exceed your total assets. It is not that difficult to qualify for insolvency when you have had a foreclosure and may be a perfect solution to your problem. Remember, we are always going to ask the bank to waive the 1099, this is worst-case-scenario stuff.

If you lost your property in foreclosure or short sale, and you did $40,000 dollars worth of work on it (and had receipts to prove it) the IRS would take the $40,000 dollars off your taxes against the $60,000 you owe and you’d owe taxes on just $20,000 – this is a sample of what “adjusted basis” means.

As you can see, there are many options when receiving a 1099. This is why you must use a tax accountant to file your taxes the first year after losing a property in distress. If you simply sell your house for a profit, then you would owe taxes on the profit earned. It is still a good idea to work with an account as you may have adjusted basis write-offs that you are not aware of.