Underwater Homeowners Could Face Extra Tax Burden

According to economists, nearly 11 million American homeowners have a negative equity in their homes, often called “underwater.” In real dollars that means Americans owe $805 billion more than the value of their secured residence. The good news is that the number of underwater mortgage loans is declining. The bad news is that the remaining homeowners may be hit with an additional tax.

Federal tax law requires that if a lender writes off any part of your loan, a debt forgiveness is created that must be reported to the IRS and may be included as income. In other words, you can lose your home, owe tax on top of the remaining debt, and owe additional income tax. For the last seven years Congress made an exemption for underwater home mortgages. That exemption expires on December 31, 2013. It is unclear whether Congress will extend that exemption again.

Checkett & Pauly routinely advises its clients not to enter into short sales, and this is one such reason. It is also important to realize that debt forgiven in a bankruptcy proceeding is never subject to income tax. Our country’s solution to the mortgage loan crisis will continue to unfold in the coming years.