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Mortgage Borrowers Lose Important Income Tax Protection

Mortgage Borrowers Lose Important Income Tax Protection

The Mortgage Forgiveness Debt Relief Act was NOT renewed for 2018 and that means more people will be filing for bankruptcy this year.

Congress passed the Mortgage Forgiveness Debt Relief Act as a way for lenders to deal with the housing crisis in 2007. This law exempted purchase money residential mortgage write-offs from being deemed taxable income for income tax purposes. If a homeowner couldn’t pay a mortgage she would not be required to pay income taxes if she received a 1099 from the mortgage servicer.

Since the Relief Act was not renewed, the only reliable way a borrower can avoid getting hit with income tax on loan forgiveness is by filing for Chapter 7. Bankruptcy works because debts discharged are NOT taxable for income tax purposes. 26 U.S.C.A. §108(a). Another option is to claim insolvency by filing an IRS 982 Form, but there are strict requirements to demonstrate insolvency.

Here is a common scenario to show how this Act helped prevent bankruptcy:

A homeowner has a $200,000 mortgage and can’t make the payments on the loan because of job loss or serious illness resulting in unpaid medical bills, two of the most common reasons people find themselves overburdened by debt. The home is foreclosed upon by the bank which sells the house at auction for $150,000. The bank then sends the homeowner a 1099(c) for $50,000.00 representing the write-off of the unpaid debt. The IRS thinks there is $50,000 in income on which to collect taxes from the borrower.  Until this year, the Mortgage Forgiveness Debt Relief Act protected consumers who had lost their homes against claims of unpaid income taxes.

As stated above, the only reliable solution at this point is bankruptcy which isn’t necessarily a bad thing. Bankruptcy is designed as a fresh start. The process of mortgage foreclosures is halted during Chapter 7 cases, buying time for the homeowner. If a debtor feels confident that mortgage payments will be made once unsecured debts are discharged, Chapter 7 could be beneficial and gives a debtor time to enter into a reaffirmation agreement with the mortgage lender.

However, the non-renewal of this act stings. It means that many citizens who are suffering from debt and not familiar with bankruptcy law, will be forced to pay income taxes unnecessarily for properties they lost. Money that would have gone into their pockets and to support their family now has to go to the government. The greatest indignity is first losing your home and then being forced to pay income taxes for property you cannot even live in.

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