As everyone in the country knows, the real estate and mortgage industry has been in trouble over the past few years. Thousands of families find themselves in financial trouble due to drastic rate increases in adjustable rate or interest only mortgages. Most people failed to consider the possibility of the huge increases upon entering the agreements. Only now, they find themselves with mortgage payments that they cannot afford to pay. Often, foreclosure is the only option available to these struggling families. However, there is one important aspect of a foreclosure that people forget – the resulting tax liability.
Foreclosure is always the last resort for someone struggling to make mortgage payments. People usually think it will be the end of their problems. However, the IRS considers debt canceled through foreclosure to be part of a taxpayer’s income. The IRS feels that it is entitled to the appropriate income taxes on that money. It also has access to every taxpayer’s financial information so it can ensure the appropriate taxes are paid. And as most of the country already knows, the IRS is very aggressive in collecting taxes that they know are outstanding and feel they deserve.
Forecasts indicate that over 20% of the loans made sine 2005 to people with weak credit using interest only or sub prime loans will end in foreclosure. Typically, these loans require little or no down payment and begin with extremely low payments that quickly rise with rate adjustments. Due to paying so little toward the principal amount and the lowering value of homes across the nation, people are increasingly finding themselves upside down in debt with huge mortgage payments.
"The tax laws are far too complex for borrowers to understand," claims Kurt Eggert, a professor at Chapman University Law School. "There are distinctions between selling a house for less than the loan amount and losing the house in foreclosure. It is crucial to get expert tax advice to sort through the bewildering complications. The whole concept can be counterintuitive – your home has declined in value and you lose it. Then the IRS says you owe tens of thousands in taxes because you got a windfall when the debt was forgiven."
Foreclosures are not the only way to end up with this type of tax liability though. The other is when a homeowner sells his or her house for less than the value of the mortgage and the bank will just forgive the difference. In those situations the homeowners is technically supposed to report that amount as income. This is known as a "1099 shortfall" which is an IRS policy that treats forgiven debts as income, even if a taxpayer has nothing to show for it.
So many people across the country are finding themselves in serious financial trouble. Lenders encouraged hundreds to refinance their houses for more than the home's fair-market-value. This was the case with Agnes Mouser. She is a 65-year-old widow who was hoping to pay off her credit card debt by taking out money with a refinance. "A real nice young man came out to see me," Mouser noted. "He could have been my grandson." The appraiser her bank sent out valued her mobile home at $43,500 in 2000 by using two new standard homes as benchmarks for calculating the value. The bank then agreed to let her borrow $34,730 against the value of her house. She paid the bank over $2,500 in closing costs and her loan carried an interest rate of nearly 15%.
When Mouser realized she could not meet her monthly payments in 2003, she contacted a lawyer who informed her that the county valued her home at less then half of what the bank had – only $19,970. Fortunately for Mouser, her bank forgave the difference. Unfortunately, the IRS did not. Soon thereafter, Mouser got a tax bill for over $10,000.
Thousands of taxpayers across the country are facing massive IRS tax liabilities with little chance of relief. With all the attention this issue is getting, Congress is finally beginning to consider legislation to help lower the burden on these people who are facing such huge financial problems. Senator Debbie Stabenow and Senator George Voinovich sponsored a bill to eliminate the federal rule that considers mortgage relief taxable income. The White House has already indicated support for Stabenow’s bill and President Bush claimed he hopes to include Stabenow’s ideas in his home ownership relief initiative. However, before a bill can go to the White House, Congress must approve it. Currently, no progress has been made on Stabenow’s bill, which has been sitting in Congress since May.