The impending expiration of the Mortgage Forgiveness Debt Relief Act has economists and underwater homeowners concerned about a future with enormous tax bills that people can ill afford.
Modesto Chapter 7 bankruptcy lawyers know there has been a lot of discussion in Washington about whether and how to extend relief, but the concern is that in a contentious election year, getting both sides to agree on anything is a long shot.
Here's what is at stake:
Normally in a foreclosure or loan modification, whatever the difference between what you previously owed and what the home resold for or what your new loan amount is, will be treated as income. That means you would have to pay income taxes on it. However, as the government was beginning to see signs of a financial crisis back in 2007, Congress passed this bill in an effort to temporarily suspend such tax hits.
That was major because if someone was extremely upside down on their home, there would be no way they could afford to pay tens of thousands of dollars in taxes after they were forced into foreclosure.
But now that relief is set to expire at the end of this year, which could effect millions of homeowners. There have been some bills proposed that would extend it through the end of 2013, with one even receiving a stamp of approval from the Senate Finance Committee. However, it's not clear how likely it is to pass into law.
This is especially concerning because of a $26 billion settlement agreement inked earlier this year by five major banks and attorneys general in 49 states. The deal stemmed from an effort to rectify the extensive foreclosure abuses by lending institutions. The money is slated to provide homeowners relief in the form of credits and loan modifications.
However, if the debt relief act expires, it may be a wash anyway if homeowners have to pay taxes on forgiven debt.
This is where a bankruptcy may help.
If you're behind on your mortgage payment, first of all, you may not qualify for certain loan modifications anyway. By filing for bankruptcy, you receive an automatic stay, which halts any foreclosure proceeding and stops creditors from harassing you. This may provide you enough time to get your finances back on track.
The second thing that a bankruptcy can do, particularly a Chapter 13, is allow you to restructure your debts in such a way that you will be able to afford making your monthly payments - and therefore keep your home.
Unfortunately, taxes aren't usually dischargeable. However, there are always exceptions. Generally, your tax debts would have to meet the following criteria to qualify:
1. The filing due date for the return was at least three years ago.
2. The return was filed at least two years ago.
3. The tax assessment is at least 240 days old.
4. The tax return is in no way fraudulent.
5. You are not guilty of tax evasion.
However, debts discharged in bankruptcy are not considered taxable. This means that if your mortgage debt was forgiven in a Chapter 7 bankruptcy (as opposed to in a foreclosure), you would not have to pay taxes on that amount.
So if you are underwater on your home, bankruptcy may actually be the smartest way for you to avoid going broke while getting back on track financially.