Delinquent Borrowers May Get a Tax Surprise

Delinquent Borrowers May Get a Tax Surprise

For homeowners seriously delinquent on their mortgages and hoping for some relief, the IRS has bad news: If your lender agrees to modify your loan and forgive any part of your debt, you could owe federal income taxes on the amount forgiven.

When personal debts are canceled by a creditor, the amount forgiven is treated as ordinary income under the Internal Revenue Code unless the taxpayer is insolvent or bankrupt. And the lender is required by law to report the amount canceled to the IRS.

This is especially bad news for the growing numbers of credit-impaired sub-prime borrowers who find themselves "upside down" in the current market: They owe more on their mortgages than the value of their houses, thanks to noxious combinations of zero down payments, declining property values and hefty payment increases they can't afford.

Proposed new, bipartisan legislation on Capitol Hill could soften some of the effects on financially stressed homeowners, however. The Mortgage Cancellation Tax Relief Act of 2007 (HR 1876) would amend the tax code to exempt debt forgiveness on principal home mortgages from being treated as income.  The legislation potentially could assist many other homeowners in financial trouble who negotiate pre-foreclosure "short sales" or deeds in lieu of foreclosure, or whose foreclosure proceeds are insufficient to pay off their mortgage debt.

We'd love to hear any comments you'd like to leave on this proposed new legislation.  Just click the Comment link below.