Mortgage modifications  

 

If your lender agrees to lower your interest rate for a temporary period of several years (or to keep it at the rate before an ARM reset), either without cost to you or by extending the term, there generally will be no adverse tax consequences to you. Under the "tax benefit rule," the tax benefit of receiving a lower interest rate is offset by the loss of the interest deduction that you would have taken on that amount. The only exception would be if more than $100,000 of your mortgage was the result of a "cash out" home equity loan, which you did not put back into remodeling. 

 

If instead of adjusting the interest or the term, your lender decides to simply lower the principal amount of your mortgage, the tax law does require you to treat that reduction immediately as income. However, if the loan is on your principal residence, thanks to a recent change in the tax laws you can exclude that income from your taxable income. 

 

One major downside for many homeowners: The new law does not cover any debt that was not put back into the home, either as the initial purchase price or for improvements. Any "cash-out" amount on a refinancing or home equity loan will generate taxable income to the extent of any forgiveness debt. Also tax benefits are denied to the extent a mortgage loan exceeds $2 million. 

 

Foreclosure  

 

In a straight foreclosure, the lender –under its legal right to do so– conducts a foreclosure sale in which the proceeds of the sale, less expenses, are used to pay off your mortgage. If the proceeds from the sale do not repay the entire mortgage, the lender can either pursue you on the mortgage note as a personal obligation or it can "forgive" any outstanding amount. We can help you in these negotiations if you require assistance. 

 

If part of the mortgage debt is forgiven after the foreclosure sale, the income imputed to the former homeowner is usually excluded from tax under the principal residence exclusion, as explained earlier in this letter. As also mentioned, the shortfall reduces the tax basis you have in your home. 

 

Short sale  

 

If you can find a buyer for your home, your lender may allow you to sell the property by removing its lien and could agree to forgive any mortgage amount that otherwise may remain unpaid. This transaction is commonly called a short sale. As in a straight foreclosure situation, the forgiven debt is typically protected by the principal residence exclusion. 

 

Deed in lieu of foreclosure  

 

Instead of having your home sold in a foreclosure sale, a lender may allow you to transfer your deed to it "in lieu of foreclosure," and at that point let you off on any otherwise remaining mortgage liability. In a deed-in-lieu-of-foreclosure situation, forgiven indebtedness income is realized to the extent that the appraised value of your home at the time the deed is transferred is less than the principal amount remaining on your mortgage. As with the foreclosure situation, the same exclusion to income rules usually apply. 

 

Sale of your home  

 

If you use one of the foreclosure options, the IRS will treat you as having sold your residence. This "sale" in turn triggers the possibility of tax on any gain realized on the sale. 

 

Fortunately, any gain on the sale or deemed sale of a principal residence is usually sheltered from tax based on the so-called "homesale exclusion" of up to $250,000 in gain ($500,000 for married couples filing jointly). If your gain is a greater or if your property does not qualify as a principal residence, it will be taxed. 

 

If a sale or deemed sale produces a loss, on the other hand, you will receive no tax benefit from it. It is considered a "personal expense" and, as such, cannot offset any other income. The IRS also maintains that the loss cannot offset any indebtedness income that otherwise must be recognized. 

 

Additionally, the IRS has announced that it is expediting the process to subordinate or remove tax liens to help homeowners. The IRS will consider the subordination of a tax lien to a secondary position when the mortgage lender is offering refinancing or a workout. The IRS will also consider issuing a certificate of discharge of the lien to enable a short sale or other sale of a residence where proceeds would not cover both the mortgage and the lien. 

Please do not hesitate to call our office with any questions.  We’re here to help.