Mortgage debt forgiveness-taxable income?

The Mortgage Forgiveness Debt Relief Act became federal law in 2007. It allowed taxpayers to avoid income taxes on unpaid mortgage debt, including debt reduced through short sale, mortgage modification or foreclosure. The original Act had been extended through 2016, but it is unclear whether a Trump presidency or Republican-controlled Congress will seek to extend this homeowner protection.

Today, U.S. Senator Debbie Stabenow (D-MI) introduced a bi-partisan bill to extend the Mortgage Forgiveness Debt Relief Act through the end of 2018, but questions remain whether there is enough political will to get this bill to President Trump’s desk or whether he will sign it.

Whether the Act is extended is a major issue for homeowners behind in their mortgage payments. For example, let’s say your home is in foreclosure, and a Final Judgment is entered in the amount of $295,000. This judgment is in rem or “against the property,” and it permits the Court to set a foreclosure sale. If the value of your home on the date of the foreclosure auction is $200,000, there is a deficiency balance of $95,000.

The lender can do one of three things. Firstly, it can choose to do nothing, which would be your best outcome. It is also your least likely outcome, because it takes so little energy to do one of the other two things.

If the lender believes the deficiency is collectible, the plaintiff could ask the Court for a money judgment against you for $95,000, which is just like any other money judgment. In Florida, for example, the lender has one year from the foreclosure sale date to seek a deficiency judgment. If Federal National Mortgage Corporation (“Fannie Mae”) owns your loan, the odds are good that this will happen to you, and they will hire Dyck-O’Neal, Inc. to collect the deficiency.

Finally, if the lender believes you are not collectible, the plaintiff can “write off” the $95,000 for tax purposes. To do this, the lender would send you a 1099C. Prior to January 1, 2017, because of the Act, the Internal Revenue Service would not consider this a taxable event. Now that the Act has expired, this could be considered ordinary income to you.