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Forgiven mortgage debt tax break set to expire

A tax break that aided distressed homeowners is set to expire in 2014. The tax break provided an exemption for mortgage debt to the traditional rule that forgiven debt is considered income. This mean that homeowners who lost their properties in a foreclosure or who sold their homes in a short sale were not subject to additional income taxes for the debt that the bank forgave as a part of that process.

In other situations where debt is forgiven, such as with credit card debt, it is considered income for tax purposes. With a credit card this may mean adding a few thousand dollars to one’s income and causing a slight increase in a tax bill, but with a mortgage it can mean tens of thousands or hundreds of thousands of dollars in additional “income” by way of forgiven debt. This is particularly true for homeowners who owe more on a home than it is worth who may have to sell the property for much less than they owe and arrange for debt forgiveness on the balance.

The tax law change will also impact loan modifications.

These tax breaks are typically needed by individuals who are already struggling to stay afloat financially, so the added tax burden may make it even more difficult. Individuals and families who need a fresh start and who need to reorganize or discharge debt may consider filing for bankruptcy. Although forgiven debt in bankruptcy will also count as income, the final result will be a structured plan to get back on track without overwhelming financial obligations.

Source: Orlando Sentinel, “’Underwater’ homeowners likely to face new tax bill,” Mary Shanklin, Dec. 17, 2013. 

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