The IRS adds to foreclosure misery. Post 23

Mitch Goldstein | Coach Mitch | May 25th, 2007

Coach Mitch’s REFLECTIONS™

“But I thought the IRS was my friend?”

If it wasn’t bad enough that the national foreclosure rate has skyrocketed more than 40% over last year’s record numbers, now the IRS has to add insult to injury.

If you are a desperate homeowner that has been granted some mortgage relief by your lender; if your lender has modified your loan and has forgiven any part of your debt, if you think that you got a good break – think again!

The IRS takes the position that any debt that is forgiven is income to you and you will owe federal income taxes on the amount forgiven. Of course, the IRS, by law, requires the lender to report the amount canceled to the IRS.

The exemption is that the taxpayer must be insolvent or bankrupt. The IRS logic is that when personal debts are canceled by a creditor, the amount forgiven is treated as ordinary income under the Internal Revenue Code. So foreclosure is not enough of a reason to cancel this rule, the IRS wants you to also be bankrupt.

This is especially bad news for the growing numbers of credit-impaired sub-prime borrowers who find themselves “upside down” in the current market. They owe more on their mortgages than the value of their houses, thanks to apparently the toxic combination of zero down payments, declining property values and significant payment increases from ARM’s that payers can not afford.

Until legislation corrects this glaring problem, homeowners are in great danger of owing tax monies even though they no longer have the asset that the taxes are owed against.

There are several ways that the homeowners in financial trouble can be hit with this onerous penalty. Anytime that the homeowner is not pursued by the lender for a mortgage loss, that would be interpreted as a forgiveness of a debt.

The common methods that owners in foreclosure now use to get out from under the mortgage debt is to cooperate with the bank and a new buyer wishing to purchase the home, albeit, for a lower amount than the outstanding mortgage balance plus fees.

For example: the homeowner would work with those who negotiate a pre-foreclosure short sale with the bank, or the homeowner gives the bank a deed in lieu of foreclosure, or where the proceeds received from a foreclosure auction are not sufficient to pay off the mortgage debt. Any amounts less than the debt owed would be considered as ordinary income and subject to taxation.

Example

Take the home that has a $400K mortgage that goes through a foreclosure. The home sells for $320K in a short sale. The homeowner is relieved of the home, and an $80K debt, and the bank does not pursue a deficiency judgment, i.e. the bank forgives the debt. That $80K is considered as ordinary income, subject to federal taxation.

If you are a Single Filer, the income tax calculation is: $15,108. plus 28% of the amount over $74,200 = $16,732 in taxes due. If you are a Married Filing Joint Filer, the income tax calculation is: $8,440.00 plus 25% of the amount over $61,300 = $13,115 in taxes due. Of course your state income tax is on top of this.

See Coach Mitch’s “Ridiculously Simple System…” ™ for details.

Only in America!