Thinking About Restructuring Your Mortgage? Why Now is the Time.

When thinking about restructuring a mortgage or even going through the foreclosure process, most homeowners are motivated by the bottom line-lower monthly mortgage payments or relief from burdening debt.

What most homeowners do not consider is that along with lower mortgage payments, they may receive an income tax bill from the Internal Revenue Service (IRS). The Internal Revenue Code, which embodies the federal tax laws, classifies some discharge or forgiveness of debt as taxable income.

In other words, if the bank agrees to foregive or reduce your principal on the mortgage you signed, then you may owe income tax on the foregiven portion of the mortgage. For example, say you restructure the mortgage on your New York State home and you consequently owe $30,000 less, that $30,000 is considered “income” and is potentially taxed. The idea is that if you borrow money, which is then not paid back, it is a debt that is not being paid back and is akin to receiving “free” money. The taxing authorities consider such foregiveness “income,” because you got the value, but are now not paying it back.

Many times, Lenders submit IRS Form 1099-C to the IRS and the forgiven debt is included in a homeowner’s income for the year, and the homeowner then must file IRS Form 982. Depending on the amount of debt forgiven, the increase in your income taxes can be substantial.

The good news used to be that The Mortgage Debt Relief Act of 2007 will be in effect until December 31, 2013. The Act allows homeowners to exclude from their taxable income any income from the discharge of debt relating to their principal residence. It applies to forgiven debt used to buy, build, or substantially improve a principal residence as long as the debt is secured by the residence.

Stated another way, if you are relieved of mortgage debt before December 31, 2013 due to mortgage restructuring or foreclosure, your transaction will probably not result in taxable income. The act permits married homeowners who jointly file their income taxes to treat up to $2 million as qualified principal residence indebtedness. The amount for single taxpayers is $1 million.

The Bottom Line– Homeowners thinking about restructuring their mortgages should discuss the tax implications with a real estate attorney who can provide advice for how to take advantage of The Mortgage Debt Relief Act.

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