Mortgage Debt Relief Act of 2007 Expired January 1, 2014

Unless the Mortgage Debt Relief Act of 2007 is extended, distressed homeowner’s face the risk of the imposition of income taxes on the discharged mortgage debt upon a short sale, short refinance or foreclosure.  The lack of the extension of this provision has resulted in the decline in the number of short sale.

The debt forgiven by the mortgage lender as part of a short sale, short refinance,  or foreclosure, could result in “cancellation of indebtedness” income.  There are though various exceptions to the application of this rule so as to avoid income taxation, such as a.  if you are insolvent, b. the debt is discharged in bankruptcy, and c. by the application of the Mortgage Debt Relief Act of 2007.  The Mortgage Debt Relief Act of 2007 generally allowed taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, debt forgiveness in connection with a foreclosure, and debt forgiven in a short sale qualified for this relief.

But the Mortgage Debt Relief Act of 2007 expired January 1, 2014 due to Congressional inaction.  This means that a personal would only be able to rely on the other exceptions to avoid cancellation of indebtedness income.

Homeowner’s only way to avoid the imposition of income tax may be the discharge of the debt in bankruptcy, if the other exceptions to not apply.

It was reported by the Urban Institute that about 2 million homeowners are at the risk of incurring discharge of indebtedness income taxation and be on the hook for $5.4 billion in extra taxes if Congress fails to renew the Mortgage Debt Relief Act of 2007.  The Washington Post reports that Congress in unlikely to address this matter until after the November elections.