WHAT CALIFORNIA HOMEOWNERS NEED TO KNOW ABOUT FORGIVEN MORTGAGE DEBT IN 2018

    The tax break for forgiven mortgage debt expired January 1, 2017 for most homeowners across the United States. This means that you may be required to pay income taxes on any debt that’s forgiven you this year.

    For example, if the lender forgives you $50,000 in debt, and your income tax bracket is 25%, you may owe the IRS $12,500!

    However, there are two exceptions to this:

    Exception #1: “Insolvency”

    There’s no tax on the forgiveness of debt if you are “insolvent” at the time of debt cancellation. Insolvent simply means that your total debts are greater than your total assets.

    In our example, assume your total assets are $20,000 and your total liabilities are $70,000. This means that your net worth would be negative $50,000. This would make you “insolvent” according to the IRS, and you wouldn’t have to pay any taxes at all on the $50,000 in forgiven mortgage debt!

    Keep in mind that when you calculate your assets, you need to include everything you own, including exempt assets beyond the reach of creditors under the law, such as interest in a pension plan and the value of your retirement account.

    Exception #2: “Non-Recourse”

    If you live in California, we have what’s known as an “anti-deficiency statute”. This means that a mortgage lender is not allowed to pursue you for the difference between the sales price and what owe on the loan.

    Using the example above, assume the lender allows you to do a short sale, but you still owe an extra $50,000. The $50,000 may be considered “non-recourse”. This means that the lender cannot require you to pay that extra $50,000 in the event of a short sale or foreclosure. In most cases, the loan must have been used to buy, build or improve your primary residence in order to qualify for this special “non-recourse” status.

    This means that forgiven mortgage debt on your vacation home or investment property may not qualify.  You may need to pay income taxes if that debt is forgiven you. You may also have to pay taxes if the forgiven mortgage debt was a cash-out refinance on your primary residence, and you didn’t use the funds from the mortgage for home improvements.

    PLEASE NOTE: THIS LETTER AND OVERVIEW IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 4681.

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