Tax Payment Requirements on Forgiven Mortgage Debt

A Federal rule that has recently been announced about how mortgage debt forgiveness is handled in tax treatments might be changed in the near future. The new regulations will require all homeowners qualified for reduction of principal reduction under HAMP, the home loan modification program put forth by the government, to pay an extremely high tax bill that, unfortunately, many homeowners simply cannot afford. The good news is that there may be a loophole available for homeowners to be exempt from paying the high tax.

During the past five years, it was not a requirement for current homeowners to pay any tax on mortgage debt on their sole residence that they have been released from having to repay. This type of debt forgiveness typically comes from a reduced principal amount through the lender, a foreclosure, or a short sale of the home.

In today’s market, any homeowner that is eligible under HAMP for the reduction alternative program is automatically awarded a reduced mortgage balance, as well as additional options that ensure that their current payments do not exceed 31 percent of their total income. The reduction takes place over a span of three years, and during this time, the homeowner is expected to continue to make timely mortgage payments.

Typically, before the economic and housing crisis, the IRS would automatically tax homeowner reductions in the mortgage principal. Starting in 2007, the Mortgage Forgiveness Debt Act would eventually prove to work as a way to restrict the amount of foreclosures that were occurring, and the IRS decided that the reduction would be tax-free.

However, the question arises on whether or not this program will remain tax-free, or if the previous rules will set back in at the start of 2014. At this point in time, there are still millions of American homeowners that are struggling financially and have less than perfect credit. It is not certain how the implementation of the tax would impact them.

The good news is that there is definitely a way out of paying this tax. The IRS states that anyone participating in the program is allowed to claim the extent of their reduction in 2013, and they will not have to worry about paying any tax liability, even if the mortgage forgiveness law is not extended through 2014.

On the IRS website, there is a document stating the specific implications of principal reductions on homeowners that are participating in the HAMP program, stating that current participants as well as individuals that are considering HAMP application are allowed options.

Additionally, homeowners that were scheduled to start receiving the reductions over the following three years are allowed to change their schedules and claim their entire reduced principal amount in their past two years’ taxes by using a form 982 through the IRS. This is a detailed process, so anyone that has any questions or is looking to change their reduction schedule would greatly benefit by consulting with a tax specialist, or better yet, a HAMP counselor.

The simple reality to these potential changes is that current homeowners do have options. They do not need to wait and see what will happen as far as an extension on mortgage relief, they can take action today and protect their financial futures.

Author: Scott Skyles

Since 1995, Scott has been involved with over $1 Billion in mortgage fundings and is recognized as an expert in residential mortgage lending. Scott is licensed and able to originate mortgage loans in all 50 states. You may follow Scott on your favorite social networks: Facebook | Google+ | Twitter

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