Northern Kentucky Homes, Cincinnati Homes

This is a key part of the Treasury Department's plan to help homeowners caught in one of the nation’s worst real estate market downturns.

• For those who’ve lost their homes – either through foreclosure or by handing the keys back to the lender - the new law prevents them from getting saddled with an onerous income tax. 
• For homeowners striving to keep their homes, it provides an incentive to refinance their mortgages without fear of higher taxes.

When home prices and sales are declining, most homeowners who fall behind in their mortgages can’t simply sell their residences to pay off their mortgages. Instead, they lose their homes in foreclosure, walk away from their properties or sell for whatever they can and give the proceeds to the lenders, in what’s known as a short sale.

Let’s say that Jane has a $250,000 mortgage on her home, but can no longer afford the payments. So she sells the home for $220,000 and gives that amount to her lender. Under the old law, the $30,000 difference between the mortgage owed and the payoff would be forgiven debt and treated as income. Thus, Jane would not only lose her home, she would owe income taxes on $30,000.

The only way to avoid the tax bill was to either file for bankruptcy or demonstrate insolvency (that the homeowner’s debts including the mortgage exceeded the value of all assets).

By contrast, the new law excludes certain forgiven or unpaid mortgage debt from taxable income, retroactive to Jan. 1, 2007.

Yes, several:

• The home must be the mortgage-holder’s principal residence, not a vacation home or rental property.
• Not all of the mortgage debt is covered, in particular “cash-out” financing used to draw money from home equity, say to pay for cars or college tuition. However, the mortgage amount that can be excluded from indebtedness income goes up to $2 million – and covers money used to acquire or construct the home, and to improve it. It also includes a refinanced mortgage, as long as it isn’t greater than the original mortgage.
• The tax break covers only years 2007, 2008 and 2009.

Check to ensure that the information listed on the forgiven debt and the fair market value is accurate, and call the lender if it is not.

Source: TurboTax