In light of the current economic crises plaguing our country, your home may be on the brink of foreclosure, or will be sold by way of a short sale. You may also have staggering credit card debt. Therefore, when entering into a property settlement agreement that involves debt forgiveness (i.e. foreclosure, short sale, and reduction in credit card debt) it is critical that you choose a matrimonial attorney that is aware of the tax consequences associated with debt forgiveness because the financial impact can be enormous.
Historically, debt that was forgiven or cancelled by a commercial lender must be included as income on your federal and state tax return and was taxable. For example, if the total amount of the mortgage debt immediately prior to the foreclosure was $220,000 and the fair market value of the property was $200,000, the amount of the debt forgiven, $20,000, was treated as taxable income. Unless of course the borrower qualified for an exception under the Federal Tax Code, i.e., bankruptcy, insolvency, certain farm debt, and non-recourse loans.
On December 20, 2007, the Mortgage Debt Relief Act of 2007 (hereinafter referred to as “the Act”) was enacted. Said Act provides financially strapped homeowners with some relief in connection with treating debt forgiveness as income. Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on a principal residence that occurred in 2007, 2008 or 2009. Moreover, there is no dollar limit if the principal balance of the loan was less than $2 million ($1 million if married filing separately for the tax year) at the time the loan was forgiven.