Christian Debt Recovery

1099 Debt Forgiveness

March 14th, 2011 |

Author: Gavin

New Law Rules Debt Forgiven not Taxable

New Law Rules Debt Forgiven Not Taxable,
Investors Now Able to Get More Properties Under Contract
Special Article Courtesy of Attorney Bob Diamond and Real Wealth Real Estate Systems

Short Sales Opportunities are Everywhere.

We all know that short sales are common nowadays. You do your marketing and homeowners call who want to sell you their property but the property is over-encumbered with debt. Often the homeowner owes more than the property is worth! Even if the homeowner wants to sell to you the homeowner will not be able to pay off the mortgage(s) from the money you pay and thus it would appear there is no deal to be made. There is a technique that fixes this problem – the Short Sale. A short sale is when the lender accepts less than the full amount owed but still releases the property from the mortgage. This creates a profit spread for the investor. The short sale can be a win for everyone – the homeowner gets out from under a mortgage he cannot afford to pay, the lender recovers more than if it had to foreclose, and you get a profitable deal.

The Tax Man Can Kill Your Deal If You Don’t Know About this New Law

The short sale can cause a significant tax bill for the homeowner. This is because of a tax concept called “debt forgiveness.” In the context of a short sale, sometimes the lender will forgive the balance that is not paid when they release the property from the mortgage as part of the short sale. They will then issue an IRS form 1099 to the homeowner.

The 1099 is a report to the IRS that the mortgage lender forgave the debt due from the homeowner and that forgiven debt may be taxable income to the homeowner! Federal tax rates generally fall around 32% so a short sale involving $30,000 could potentially result in a $9,600 tax bill! This will often kill your potential transaction. Often you will not know if the lender is going to forgive the debt until after the short sale is completed. If the debt is forgiven the homeowner could have a tax bill. That uncertainty will often make a homeowner unwilling to participate in the short sale.

A New Law Fixes the Problem

The new Mortgage Debt Forgiveness Relief Act was signed into law by President Bush on December 20, 2007 can help you overcome the homeowner’s objection. This law can eliminate taxes that would often be due from the homeowner in the event of a short sale.

Highlights of the New Law

In order to qualify for the exclusion from tax liability under the new law, the homeowner’s situation must meet several criteria:

1.       The debt forgiven must have been used to buy, build or substantially improve the principle residence and must be secured by that residence (not home equity loans or cash-out refinances unless the money was used to fix up the home.        If the home equity line or cash from the cash-out refinance was used to fix up the home then debt forgiven on those loans will qualify as non-taxable under this new law);
2.       Debt used to refinance may also be eligible for exclusion, but only up to the amount of the old mortgage principle, just         before refinance;
3.       The property must be the primary residence of the homeowner (no second homes, investment properties, or business         property);
4.       The homeowner must have: owned the home for at least 2 years; and lived in the home as their main home for at least     two years.
5.       The maximum amount of the debt is $2,000,000 or $1,000,000 for a married couple filing separate returns;
6.       The debt must be forgiven on or before December 31, 2009; and
7.       The debt forgiveness must be related to a decline in: the value of the residence or the financial condition of the       homeowner.

Some Additional Details

The law has lots more details and covers subjects not related to the short sale debt forgiveness. It is sufficiently complex that you need an accountant to make the final call over whether a homeowner’s situation will be taxable. That being said, if a homeowner has an objection to the short sale because of the debt forgiveness, if the situation is one where the homeowner is selling their primary residence, the debt is less than $2,000,000 and it is the mortgage used to purchase the property, you can tell the homeowner that under the law they will probably not have a tax bill if the lender forgives the debt. Advise them to consult with their accountant to be sure. In the event they do not have an accountant you should have a referral ready for them so they can consult with an accountant (at their expense)

Summary

This new law can help you overcome the objection of a homeowner you are working with to signing an agreement of sale because of their potential tax bill. It will help you make more deals and more money.

You can meet Bob Diamond live and in person, in Connecticut, Oct. 25-26 at the 5th Annual New England Real Estate & Investors Conference and Tradeshow. Registration is available at: www.CTREIA.com