In typical fashion, the United States Congress waited until the eleventh hour to address the looming “fiscal cliff.” In doing so, Congress extended a number of tax exemptions, including the 2007 Mortgage Debt Relief Act (the “Debt Relief Act”). The Debt Relief Act was scheduled to sunset on December 31, 2012. But pursuant to the American Taxpayer Relief Act of 2012, the Debt Relief Act is now extended until December 31, 2013. This is great news for our local real estate economy.
The general rule is that the forgiveness of debt is a taxable event. Thus, unless a tax exemption applies, property owners generally must pay income tax on the forgiveness of debt following a short sale, foreclosure, or deed in lieu of foreclosure. This “phantom income” tax burden is particularly onerous for struggling homeowners who cannot afford their mortgage in the first place.
The Debt Relief Act, however, provides an important tax exemption for many distressed homeowners. Pursuant to the Debt Relief Act, the forgiveness of debt used to purchase or improve a principal residence is not a taxable event. Accordingly, in many cases, homeowners can short sale their distressed property with no tax liability. And if the short sale transaction is negotiated correctly, the homeowner will have no personal liability for the mortgage deficiency following the short sale.
Although the Debt Relief Act only applies to loans used to purchase or improve a principal residence, in most cases, other tax exemptions apply to Arizona property owners, which minimize or eliminate tax liability following a short sale.
Perhaps of greater importance, is that the $250,000 tax exemption ($500,000 for married couples) concerning income from the sale of a principal residence remains in effect. 26 U.S.C. § 121. This important exclusion had nearly been forgotten since the Great Recession, but due to the incredible appreciation of real estate in Maricopa County in 2012, this exclusion is once again relevant, now that many homes have regained equity.
Contact our office today to schedule a consultation with attorney Christopher J. Charles to discuss available options regarding distressed properties or other real estate matters.