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Last Minute Relief for Cash Strapped Homeowners

Financial Planning

January 2008

Last Minute Relief for Cash Strapped Homeowners

As a Christmas gift to middle class taxpayers - and those who have been hit hard by sub-prime mortgage woes - Congress passed, and the President signed into law, several last minute bills aimed at helping these groups. The Tax Increase Prevention Act of 2007(TIPA) was yet another “patch” to our income tax laws to reduce the number of taxpayers subject to the Alternative Minimum Tax. The Mortgage Forgiveness Debt Relief Act of 2007 was enacted to provide tax relief to homeowners presently facing foreclosure on their properties.

Alternative Minimum Tax Patch

Without the enactment of TIPA, approximately 25 million taxpayers would be facing an average $2,000 increase in their 2007 tax bill. The large increase comes from the expiration of another patch that expired in 2006. The enactment of TIPA will protect millions of Americans from a tax that was never intended for them in the first place.

While this legislation is welcome, it comes at such a late hour that the Internal Revenue Service expects it to cause major delays in return processing in 2008. If you file any of the following forms, the earliest the IRS expects to be able to process your return is February 11, 2008:As a result, you might need to plan on getting your refund a little later than normal this year.

Mortgage Debt Forgiveness

Many families faced the prospect of losing their homes in 2007 and an even greater number are expected to lose their homes in 2008 and 2009 through foreclosure. Typically, a mortgage lender will foreclose on a home and then sell the property for less than the outstanding balance on the loan - an average of 40% less. When this happens - and if the lender chooses not to pursue collection of the remaining balance from the borrower - it creates taxable income in the form of debt forgiveness.

In December 2007, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 (Debt Relief Act). Its purpose is to prevent families that are already facing huge debt burdens from incurring even more debt in the form of taxes they cannot pay. The Debt Relief Act exempts up to $2 million of debt forgiveness income resulting from foreclosure on a taxpayer’s principle residence from taxation. To qualify, the debt must have been incurred to either acquire or substantially improve the borrower’s primary residence. Loans issued to refinance qualifying debt will also be eligible for the exemption.

In some cases, lenders have chosen to rework troubled debt to reduce monthly payments. They have chosen to do so because the recovery through foreclosure would be insufficient. Technically, this also creates debt forgiveness income. The Debt Relief Act also exempts this income from tax. This provision compliments the initiatives of the private sector to help borrowers by, in many cases, delaying rate increases on adjustable rate mortgages (for up to five years) and otherwise reworking debt to make it more affordable for the taxpayer.

During the years of increasing home values, many taxpayers refinanced to “cash out” the equity in their homes. Repayment of credit card debt, financing children’s education and other needs caused homeowners to look to equity in their homes as a source of funds. Any debt incurred for these purposes will not qualify for the exemption. In addition, debt issued to purchase a second home or vacation home will not qualify.

Any income excluded from tax will reduce the taxpayer’s basis in their home. Since the gain on the sale of most homes will not exceed the amount already sheltered by other tax provisions ($250,000 for single filers and $500,000 for joint filers), this should have no negative effect on most taxpayers. Even if the ultimate gain is taxable as a result of the basis reduction, the taxpayer will be trading income taxable at higher ordinary income rates for income taxable at lower capital gains rates.

The exemption applies to debt forgiveness resulting from transactions occurring beginning January 1, 2007 and ending on December 31, 2009.

The new law also provides a few additional tax breaks for those paying mortgage insurance premiums and widows or widowers.

These changes, along with initiatives by the private sector, make it imperative for homeowners faced with foreclosure to tackle their problems head-on. Just like homeowners do not want to face the prospect of losing their homes, lenders typically have no interest in taking those homes, because it generally increases their loss on the real estate. Many times, a show of good faith and willingness to work with a lender will stave off foreclosure and provide needed relief to families in crisis.

Happy New Year

The combination of AMT relief and mortgage debt forgiveness relief can make 2008 a much brighter year than many taxpayers otherwise would have faced. The tax savings resulting from these new provisions will take some of the financial pressures off of families and help them to restructure their debts. If you are working to create a new financial plan for your life, give us a call. We are here to help you work toward a successful year.
 

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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