Mortgage Forgiveness Debt Relief Act of 2007

On December 20, 2007, President Bush signed into law the "Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648)." It provides tax relief to certain homeowners who lose their principal residence in foreclosure, it extends the mortgage insurance premiums deduction, allows a surviving spouse up to $500,000 of exclusion of capital gain from sale of main home for up to two years after date of death, increases penalties for filing late partnership returns, and creates a new penalty for filing late S-corporation returns.

Certain Cancelled Debt Nontaxable When Principal (Primary) Residence Foreclosed

When a lender forecloses on a home and then sells the home for less than the borrower’s outstanding mortgage and forgives all or part of the unpaid mortgage debt, the cancelled debt would in most cases be considered taxable income to the homeowner. The Mortgage Forgiveness Debt Relief Act of 2007, EXCLUDES from gross income up to $2 million of discharged indebtedness that is secured by a taxpayer's primary residence and is incurred in the acquisition, construction or substantial improvement of the primary residence. This special tax relief is available for only three years retroactive to January 1, 2007, and ending December 31, 2009.

Example: Maria’s primary residence is subject to a $200,000 mortgage debt. Maria’s creditor forecloses in 2007. Due to a declining real estate market, the residence is sold for $160,000 later that year. Maria has $40,000 discharge of indebtedness income. Before the new law, the $40,000 cancelled debt would have been includible in Maria’s gross income and taxed at the ordinary tax rates. Under the new law, it is now excluded.

Mortgage Renegotiations

Mortgage renegotiations are now part of the new tax laws exception in addition to covering foreclosure situations. When a lender determines that foreclosure is not in its best interest, it may offer a mortgage workout under which the terms of the mortgage are changed to result in a lower monthly payment. One workout plan organized by the Bush Administration and a group of lenders would forego adjustable rate resets for up to five years. This and other mortgage workouts technically would result in forgiveness of indebtedness income (Cancelled debt) that would be taxable to the homeowner if it were not for the new law.

Indebtedness

The new law applies to qualified primary residence indebtedness which means acquisition indebtedness. This is indebtedness that is generally incurred in the acquisition, construction or substantial improvement of the principal residence of the taxpayer and is secured by the residence. It also includes refinancing of such debt to the extent that refinancing does not exceed the amount of the original indebtedness. Unlike the current deduction for qualified residence interest that includes interest on $1 million in acquisition indebtedness plus $100,000 of home equity debt, the new mortgage debt exclusion includes $2 million in acquisition indebtedness, but counts no home equity debt not used for renovation.

Principal (Primary) Residence

A taxpayer’s principal residence for purposes of the new law is the same as that under Internal Revenue Code Section 121 for the home sale capital gain exclusion.

A principal residence is generally the one in which the taxpayer lives most of the time. However, the determination of a taxpayer’s principal residence is based on “all the facts and circumstances.”

NOTE: The cancelled mortgage debt exclusion does NOT apply to vacation homes or other second residences!

Adjusted Basis of Home AFTER Mortgage Forgiveness Debt Relief

The basis of the taxpayer’s principal residence is reduced by the amount of cancelled mortgage debt excluded from income under the new law.

Mortgage Forgiveness Debt Relief Not Available in Certain Situations

The new law disallows the exclusion of cancelled mortgage debt if the loan is discharged because of services performed for the lender. The exclusion is also disallowed to taxpayers in Chapter 11 bankruptcy.

Mortgage Insurance Premiums

For tax year 2007, there is a new deduction for certain mortgage insurance premiums commonly known as PMI (Private Mortgage Insurance).

Mortgage insurance can be provided by the Veterans Administration (VA), Federal Housing Administration (FHA), Renting Housing Association (RHA), and Private Mortgage Insurance (PMI) as defined by Section 2 of the Homeowners Protection Act of 1998.

What is Mortgage Insurance?

Mortgage Insurance is normally required when you buy a house with less than 20% down. Mortgage insurance is a type of guarantee that helps protect lenders against the costs of foreclosure.

New Tax Law

On December 20, 2006, President Bush signed into law the "Tax Relief and Health Care Act of 2006" which created the new deduction for mortgage insurance premiums for ONE year, which was 2007.

With the enactment of the "Mortgage Forgiveness Debt Relief Act of 2007", the mortgage insurance premiums deduction is EXTENDED until December 31, 2010.

Section 6050H of the Internal Revenue Code of 1986 (relating to mortgage interest) is amended by adding at the end the following new subsection:

In general - Premiums paid or accrued for qualified mortgage insurance by a taxpayer during the taxable year in connection with acquisition indebtedness with respect to a qualified residence of the taxpayer shall be treated for purposes of this section as interest which is qualified residence interest.

Do you Qualify for the New Mortgage Insurance Premium Deduction?

You MUST meet ALL of the following requirements:

• You must have closed on your mortgage on or after January 1, 2007. If you have a loan with mortgage insurance PRIOR to January 1, 2007, you will NOT be able to deduct the premiums unless you refinance,

• To get the full deduction, your adjusted gross income (AGI) must be LESS THAN $100,000 ($50,000 if married filing separately). The deduction gets phased out gradually between $100,000 and $109,000 ($50,000 and $54,500 if married filing separately). No deduction is available if AGI exceeds $109,000,

• The mortgage insurance premiums must be paid or accrued during the tax year.

If you take the standard deduction instead of itemizing deductions, this new deduction will not affect you since you MUST itemize deductions on Schedule A to claim mortgage insurance premiums.

Survivor’s Home Sale Exclusion

In an important development for recently-widowed spouses, the new law extends the period of time during which a surviving spouse may use the joint tax return filers’ $500,000 home sale gain exclusion before being treated as a single individual entitled only to a $250,000 exclusion. Previously, a surviving spouse was entitled to the $500,000 exclusion only when he/she could file a joint return with the deceased spouse, which is only available for the tax year in which the spouse dies.

Beginning January 1, 2008, the sale of a principal residence that had been jointly owned and occupied by the surviving and deceased spouse is entitled to the $500,000 gain exclusion provided the sale occurs no later than two years after the date of death of the individual’s spouse.

The surviving spouse in the case of a jointly owned residence continues to be allowed a step up in basis in the residence for the deceased spouse’s one-half share. The $500,000 exclusion is in addition to that benefit.

Tax INCREASES

In order to offset the decreased tax revenues with the cancelled mortgage debt exclusion, new penalties apply to late filed partnership and S-corporation returns.

There is an increase in the failure to file penalty for partnerships from $50 to $85 per partner, per month, up to 12 months beginning December 21, 2007.

NOTE: The penalty has been INCREASED by $1 from $85 to $86 per partner for tax years beginning in 2008. This penalty increase was included in the Prevent Taxation of Payments to Virginia Tech Victims and Families Act, which President Bush signed into law on December 19, 2007.

There is a new failure to file penalty for S-corporations of $85 per S shareholder, per month, up to 12 months.

Also, there is an increase in corporate estimated tax payments for corporations with assets of at least $1 billion. The increase is an additional 1.5 percent for payments due in July, August and September 2012.