There are multiple laws and bills that have been passed in the last few years due to the current economic and political climate, including the Mortgage Forgiveness Debt Relief Act, Senate Bill 1178 and the House of Representatives Bill 6133, Some of these may affect you. Read a brief summary of each below:
Mortgage Forgiveness Debt Relief Act (2007) - The Mortgage Forgiveness Debt Relief Act was was enacted on December 20, 2007. This Act generally allows homeowners to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring and mortgage debt forgiven in connection with a short sale or foreclosure qualifies for the relief. This provision applies to debt forgiven in calendar years 2007 through 2012.
Q: What is cancellation of debt?
A: If you borrow money from a lender and the lender later cancels or forgives the debt, you may have to include the canceled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
Q: Does the Act apply to all canceled or forgiven debt?
A: No. The Act applies only to forgiven or canceled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness. The maximum amount you can treat as qualified principal residence indebtedness is $2 million or $1 million if married filing separately.
Q: Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to refinance a home?
A: Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified.
Q: Is Cancellation of Debt income always taxable?
A: Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:
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Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
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Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
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Insolvency: If you are insolvent when the debt is canceled, some or all of the canceled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
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Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
California Senate Bill 1178 - Senate Bill 1178 was introduced February 18, 2010 by Senator Ellen Corbett to amend Section 580b of the Code of Civil Procedure, relating to deficiency judgments on homeowners who have sold their home under a short sale agreement. Under existing law, if a homeowner defaults on a mortgage used to purchase a home - commonly referred to as a "purchase money mortgage" - the homeowner's liability on the mortgage is limited to the property itself. However, homeowners who refinanced the original purchase debt, even if only to obtain a lower interest rate, were not extended the same protections. Senate Bill 1178 would have extended this anti-deficiency protection to homeowners who have refinanced, but only to the extend that the refinance is used to pay debt incurred to acquire, construct, or substantially improve the real property. This means that homeowners who refinanced to pull cash out of the equity in their homes would not be covered by the bill.
Analysis: The primary argument in favor of the bill is that homeowners are generally unaware that refinancing their home mortgage causes them to lose the anti-deficiency protection of existing law. The main argument in opposition of the bill is that it perpetuates over-leveraging of a homes equity and that it encourages a borrower from strategically defaulting on their loan when they have the ability to pay. The California Association of Realtors was in support of the bill while many associations from the banking and financial industry were against the bill.
Current Status: After being introduced in February 2010, the bill was amended and passed by the California State Assembly on August 19, 2010. The bill was then sent to Governor Arnold Schwarzenegger for signature, who vetoed the bill on September 30, 2010. The reason for the veto was that the proposed law would interfere with existing contracts between the homeowner and the lender. The bill is now under the Senate Floor Unfinished Business status.
H.R. 6133: Prompt Decision for Qualification of Short Sale Act of 2010 - This Act would require the lender or servicer of a home mortgage, upon a request by the homeowner for a short sale, to make a prompt decision whether to allow the sale. It would amend Chapter 2 of the Truth in Lending Act to require loan servicers to respond within 45 days to a written request for a short sale. The homeowner must include a copy of an executed contract between the homeowner and prospective buyer that is subject to approval by the loan servicer along with the written request for a short sale. If the homeowner does not receive a written notification of whether such request has been approved, or that the request has been approved subject to specified changes, or that additional information is required, such request shall be considered to have been approved by the loan servicer.
Current Status: This bill is in the first step in the legislative process. Introduced bills and resolutions first go to committees that deliberate, investigate, and revise them before they go to general debate. On September 15, 2010 this bill was referred to the House Committee on Financial Services.
