Did you know that forgiven debt - including that related to mortgages - can be considered income and taxed by the Internal Revenue Service? In recent years, struggling homeowners have been provided with a tax break that could save them from additional charges related to forgiven debt, but that program apparently expired shortly before the new year. Now, some Washington residents could find themselves in significant financial trouble even after seeking debt relief for their mortgage woes.
It may not make sense to pay income tax on forgiven debt; after all, you never earned the money. Although borrowers are not taxed on money they receive from lenders - they are obligated to repay the amount - when the debt is forgiven, it is considered income. If a borrower had $75,000 in debt forgiven, for example, that could be considered taxable income. In some cases, borrowers may qualify for insolvency protection, which would remove the tax burden if the borrowers' liabilities are larger than their total assets.
Tax experts say that the exemption protected borrowers who could not refinance their mortgages and were forced to sell their homes through a short sale process. In those situations, lenders allow borrowers to sell the property for less than the remaining amount on the home loan. Borrowers can often negotiate with the lender to have the modest remaining balance forgiven. Debt relief was available for homeowners who went through home sales, but it could also be used by those whose debt was reduced through a change in mortgage terms.
Although fewer owners are struggling with financial crisis in 2014 than during the height of the Great Recession, debt relief is still a hot topic that needs to be addressed. It is not clear whether national leaders will extend the added protections that homeowners had enjoyed in recent years; without those financial shields, more Americans could find themselves filing for bankruptcy and facing a variety of other serious financial challenges.
Source: The Boston Globe, "For some, mortgage relief will mean a big tax bill" Michelle Singletary, Jan. 09, 2014