President Bush, on December 20, 2007, in signing The Mortgage Forgiveness Debt Relief Act of 2007, stated:
"The bill I sign today will help this effort by ensuring that refinancing a mortgage does not result in a higher tax bill. Under current law, if the value of your house declines and your bank or lender forgives a portion of your mortgage, the tax code treats the amount forgiven as money that can be taxed. And of course, this makes a difficult situation even worse. When you're worried about making your payments, higher taxes are the last thing you need to worry about. So this bill will create a three-year window for homeowners to refinance their mortgage and pay no taxes on any debt forgiveness that they receive. And it's a really good piece of legislation. The provision will increase the incentive for borrowers and lenders to work together to refinance loans — and it will allow American families to secure lower mortgage payments without facing higher taxes."
Quite simply, the way the new law functions is by amending Code Section 108. A little background: Code Section 61 indicates that gross income includes all income from whatever source derived. Code Section 108 addresses income from discharge of indebtedness. This amount is taxable unless it results from a title 11 case, insolvency, or is qualified farm indebtedness. The new addition to non-taxable cancellation of indebtedness (COD) reads as follows: the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010. That's it, in a nutshell.
The basis of the principal residence is reduced by the amount excluded. Qualified principal residence indebtedness means acquisition indebtedness (under IRC 163(h)(3)(B), but substitutes $2,000,000 for the $1,000,000 cap under acquisition debt). The effective date of the act is for discharges of indebtedness on or after January 1, 2007.
The IRS website has a web section on foreclosures. If you go to www.irs.gov, and type in foreclosure in the search box, you will find the following:
Special Web Section Unveiled for Homeowners Who Lose Homes; Foreclosure Tax Relief Available to Many
IR-2007-159, Sept. 17, 2007
WASHINGTON — The Internal Revenue Service unveiled a special new section today on IRS.gov for people who have lost their homes due to foreclosure. The IRS also reassured homeowners that, although mortgage workouts and foreclosures can have tax consequences, special relief provisions can often reduce or eliminate the tax bite for financially strapped borrowers who lose their homes.
Other changes: The Mortgage Insurance Premiums that can be deducted as interest has been extended for 2008 through 2010.
Sale of residence has been modified for sales or exchanges after December 31, 2007. In the case of a sale or exchange or property by an unmarried individual whose spouse is deceased on the date of such sale, the $500,000 exclusion applies if such sale occurs not later than 2 years after the date of death of such spouse and the regular requirements for the special rules for joint returns under IRC 121 apply.
Penalties: Here is the bad news. The failure to file partnership penalties increase from $50 per partner per month, for a maximum of 5 months, up to $85 per partner, per month, for a maximum of 12 months. In other words, the penalty goes from a maximum of $250 per partner to a maximum of $1020! This is effective December 20, 2007.
For S corporations, the penalty is also the $85 per month, maximum of 12 months, with an effective date of returns required to be filed after December 20, 2007.
There are also changes made that result in an exclusion from income for benefits provided to volunteer EMS and firefighters, modification of the prohibition against full-time students from qualifying for low-income housing credit, and changes to modify tests to qualify as cooperative housing corporation.
