Forgiveness of Debt

So let’s really be straight about this entire Forgiveness of Debt Tax thing:

*It is a tax;

*It comes to us from the federal government (IRS);

*It involves anytime we have a debt owed;

*When a lender forgives that debt owed (as in a short sale or foreclosure), we have additional income of a like amount.

*That income is taxed to us at the same rate of our ordinary employment earnings;

*Every short sale will generally produce some forgiveness of debt;

*Every foreclosure will also generally produce forgiveness of debt (commonly misunderstood);

*Up until December 31st last year, most of your customers were exempted by a law that expired at the end of last year.

*That law is not expected to be extended or reintroduced as far as we can determine.


So how do we handle this tax matter in 2015?

*It is still a tax;

*It did not go away;

*The previous Mortgage Debt Forgiveness Relief Act did expire last year;

*We have a marvelous law still in place that provides an identical outcome;

*We call it the insolvency exemption;

*It is a well-established tax law that is a huge part of our practice.


So what is this insolvency exemption and how does it work?

*It also has been a good law for many years before the Recession;

*It is a good law now and won’t expire;

*It helps owner occupants as well as non-owner occupants avoid taxes;

*It eliminates forgiveness of debt tax for most of our clients;

*We look at the seller’s debts and assets and determine what level of assets versus liabilities (debts);

*If debts exceed assets, then no tax;

*If assets exceed debts, tax only payable to the extent of the solvency.

*It causes sellers to feel comfortable selling short knowing their tax outcome is favorable.

*Most sellers will qualify and pay no tax. Others pay reduced amount of tax


What is the Biggest Misunderstanding regarding this Rule?

*Many parties are out there today advising parties to just go through foreclosure as that is a more favorable outcome… WRONG!;

*Foreclosure will almost always produce a greater tax cost and far greater credit impairment than a short sale;

*A seller has far more control in a short sale.

Here is a link to a video explaining all of this:
The Link: https://www.youtube.com/watch?v=FOKjjJnXl48

Happy Investing! 


Today's blog courtesy of Ed McFerran, McFerran and Burns