Taxation of Home Mortgage Debt Forgiveness

        Home values in America have dropped substantially in the last five years, and many people, who have found their homes worth less than they owe on the mortgage, have been forced to abandon their homes in short sales, deeds in lieu of foreclosure, or court foreclosures. As a bankruptcy lawyer I have dealt with a number of people in this situation, and while losing one’s home is not a happy experience, I know that in many cases the homeowners can at least the avoid owing a deficiency to the mortgage companies, when the house sells for less than the debt.

        When a homeowner shorts sells a home or grants his mortgage company title in a deed in lien of foreclosure, the agreement with the mortgage company usually calls for no additional liability once the transaction is completed. When a home is foreclosed the court can enter a deficiency judgment ordering the homeowner to pay the mortgage company the difference between the sales price on the home and the amount owed to the mortgage company, but in many cases the court does not enter this deficiency judgement, and the homeowner ends up owing nothing more.

        Beginning on January 1, 2013 however, the homeowner might face an income tax liability on the amount of mortgage debt that does not get repaid in one of the above transactions. The general rule under Section 108 of the Internal Revenue Code provides that cancelled indebtedness is taxable income for the debtor. However, when the housing market collapsed, Congress passed a temporary law relieving distressed homeowners of this liability, provided the cancelled debt was the result of acquiring the house as one’s principal residence, and the acquisition indebtedness does not exceed $2,000,000 (or $1,000,000 in the case of a married individual filing separately).

        Unfortunately, like with many other recently enacted provisions of the Internal Revenue Code, this law is set to expire on January 1, 2013 unless Congress takes some last minute action to salvage the relief .