So if a house sold $50,000 short of what is owed on the mortgage, then the selling homeowners will owe federal income taxes on that $50,000. Homeowners would owe $12,500 if they are in the 25% bracket and $7500 if in the 15% tax section. Homeowners would be on the hook even if the house sold but the bank had not formally forgiven the loan in a letter. The banks must officially sign off in writing before Dec 31 2012 otherwise you will be paying a huge tax to IRS.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence per IRS guidelines. Debt reduced through mortgage restructuring as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. Up to $2million of forgiven debt can be forgiven this year, $1million if married and filing separaely per IRS.
Homeowners declaring bankruptcy could escape paying income taxes on any cancellation of debt income if the debt is forgiven in the bankruptcy even if the debtor is solvent, said Nick Jovanivuch, a board dertified tax atty in Florida.
Bankruptcy trumps everything, he said. Or homeowners might not have to pay income taxes on any cancellation of debt income by Donna White of Sacramento Bee
Here's the link for IRS