The Mortgage Forgiveness Debt Relief Act expires on December 31, 2013 and has not yet been extended by Congress. This Act is designed to help homeowners who sell their properties at a short sale or whose properties were sold at foreclosure sales from having to pay income taxes on any deficiency balance. For example, if a house was sold at a short sale for $150,000 and the lender was owed $200,000, the deficiency would be $50,000. If the mortgage company decides not to sue the former homeowner for the deficiency, but instead takes a tax write off, it will send the former homeowner a Form 1099 for the $50,000. The IRS will consider the $50,000 as income to the former homeowner who will now have to pay income taxes on this based on his tax rate.
Recognizing this will just put an additional burden on people who have already lost their homes, Congress passed the Act so that if the mortgage lender sends the homeowner a Form 1099 for the short fall, it will not be considered taxable income by the IRS. However, Congress has not yet acted to extend this law. For those living in Maryland, the state has extended this law so that the former homeowner will not have to pay state income taxes on the deficiency balance. Unfortunately for those living in the District of Columbia or Virginia there are no laws to protect these underwater homeowners from having to pay income taxes on the deficiency.
If Congress does not extend the law, the only way to get relief from having to pay income taxes on the deficiency balance is to file a bankruptcy case. The bankruptcy case should be filed before receipt of the Form 1099 from the lender.
Laura Margulies is a principal of the law firm of Laura Margulies & Associates, LLC. We represent consumers in bankruptcy and litigation matters in Maryland and the District of Columbia. To learn more about our firm visit our web site at www.law-margulies.com.