READ: Q&A: Does a short sale affect my credit the same as a foreclosure?
With the new extension, homeowners now have less than 12 months to take advantage of this tax relief. And while that may seem like a long time, keep in mind that short sales can take up to 6 months (or more) to complete. A loan modification or a deed-in-lieu of foreclosure can take at least 3 months to go through. And a foreclosure can take up to a year to finalize.
For more information, see IRS News Release IR-2008-17 or IRS Publication 4681, Cancelled Debts, Foreclosures, Repossessions, and Abandonments.
If you are a homeowner, it is important to be aware of what’s happening with the real estate market and foreclosure crisis. Too many homeowners don’t fully understand all their options when facing an underwater mortgage or foreclosure. It is critical for you to do the research and determine the consequences of any financial decisions you are about to make. When the time comes to act, you want to be prepared for every possible scenario.
The current housing market has a reported negative equity gap of approximately $3.7 trillion. This number reflects the millions of homeowners who are underwater on their mortgages and owe more than their home is worth.
READ: Housing recovery is 'halfway' there, says Trulia
Charles Engel, the vice president of RealtyTrac, recently said, “Even if [these] homeowners aren’t struggling to make mortgage payments and therefore are at low risk for foreclosure, if they need to sell sometime in the next five years it’s likely they’ll need to sell via short sale.”
If you owe a debt (such as a mortgage loan and the lender cancels or forgives part of that debt, the discharged amount (which you no longer owe) may still be taxable according to the IRS. Under the Internal Revenue Code, all types of forgiven debt are still treated as income and subject to taxes.
Fortunately, there is tax relief for struggling homeowners. The Mortgage Debt Relief Act of 2007 was introduced to allow taxpayers to exclude income (on their tax returns) from the discharged debt on their principal residence. This can include debt that is reduced by mortgage restructuring as well as debt that is forgiven relating to a foreclosure.
How does this affect you?
1. The law permanently extended tax cuts extended during the Bush years to incomes below $400,000. If you make more than that the tax rate increased from 35% to 39.6%.
2. It permanently extended Estate Tax rates except for top tax rates which were increased from 35 to 40%.
3. The Child Tax Credit, some provisions of the earned income tax credit, the Education Tax Credit, and The American Opportunity Tax Credit ("AOTC", extended through 2017) were extended. Under the AOTC the Hope Credit was modified and extended to a broader group of taxpayers, including many in higher incomes. Many who qualify will receive the maximum $2500 credit.
4. The Payroll Tax Reduction Act reduced the amount paid to Social Security in 2010 but this was not extended so in early 2013 you would have seen employee increases return to what they were - 6.2% and for self-employed 12.4%.
5. Other provisions also affected Medicare, unemployment, and the Farm Bill. TO see a complete list and details explaining these changes please see "The Fiscal Cliff and the American Tax Payer" published by the Congressional Research office.