Thanks in advance to anyone that can lend advice or point me to good resources to learn more. I’ll try to keep it short & sweet:
Bought house seven years ago for $178,000. It was less than a year after Katrina, local home stock was very short, values must have been inflated.
Went to refinance earlier this spring, new lender ordered an appraisal. Appraisal came back with a home value of $104,000. Got the $104,000 amount financed.
Right after all the final paperwork was signed off on and submitted, I received a phone call from the lender. They suggested that I check with a tax professionals regarding the loss of value in my home and the resulting drop in the our mortgage’s principal. The person on the phone couldn’t explain it well, and said something like “sometimes it matters, sometimes it doesn’t”. The implication, though, was that since I essentially traded (a) a $178,000 mortgage minus seven years of equity for (b) a $104,000 mortgage, that $74,000 driop might be considered as income on my 2014 federal tax return.
I have tried to research this on my own, but I am not finding direction specific to my situation. Might that $74K, in fact, have to count as income on my next tax return?
I’m not clear based on what you wrote, but it sounds like you had a portion of your mortgage note forgiven. This is typically called debt forgiveness. You can consult with your tax professional (google) about that specific term and the tax implications. In general debt forgiveness is considered income and is a taxable event, however with the current economic climate many specific instances of debt forgiveness have been exempted - largely around housing issues such as yours. These vary by state as well so it’s best to read the current rules in your area.
But it doesn’t appear you actually had any debt that was forgiven or even if so, it’s likely excludable see:
Canceled Debt that Qualifies for EXCLUSION from Gross Income:
Debt canceled in a Title 11 bankruptcy case
Debt canceled during insolvency
Cancellation of qualified farm indebtedness
Cancellation of qualified real property business indebtedness
Cancellation of qualified principal residence indebtedness
The exclusion for “qualified principal residence indebtedness” provides tax relief on canceled debt for many homeowners involved in the mortgage foreclosure crisis currently affecting much of the United States. The exclusion allows taxpayers to exclude up to $2,000,000 ($1,000,000 if married filing separately) of “qualified principal residence indebtedness.”
If they send you a 1099C, then you will have to explain. You are likely insolvent anyway*, but even if not you’d qualify under #5. So, no, not taxable, but you may have to explain.
But that’s only if you actually had debt forgiven.
I am not a Tax expert, but my Brother is. This is not legal advice, but that’s a great site anyway.
The $178,000 and $74,000 numbers aren’t really relevant. What matters, if anything, is what was the principal amount left on the mortgage at the time you refinanced, and the difference between that and the new principal amount of $104,000.
If part of your balance was forgiven, then that might be an income event. Talk to a tax advisor or attorney if it was to determine if that means you owe additional taxes.
If there was no forgiveness (e.g. if you swapped a mortgage with a lot of equity for a smaller mortgage with no equity and everything balanced out, or if you made up the deficit with a cash payment), then it doesn’t sound like there would be a recognized income tax event.
If the balance of the old mortgage at the time of refinance was $124,000 and the bank officer said, “I know times are tough, tell you what, I’ll tear up this mortgage note if you sign a new one for $104,000. It’s worth it for us to know that you’re less likely to file for bankruptcy if you owe $20k less, and we would rather have a high probability of some payment than a lower probability of the full payment plus a low probability but catastrophic case of bankruptcy where we get nothing.”, then that sounds like a debt forgiveness income case.
If the balance of the original mortgage at the time of refinance was $124,000 and you paid off the original mortgage with a $20k check out of your savings plus a new mortgage for $104,000, that’s just an ordinary refinance.
DrDeth: following your link led me to find this page detailing The Mortgage Forgiveness Debt Relief Act of 2007. That appears to be exactly the info I need, including the specific IRS form I’ll need to submit with my next federal return.
Don’t forget state taxes as well. Several states passes similar legislation to accomplish the same thing at the state level, but many of these did not align perfectly with the federal rules.
This is one thing that you didn’t specify : did the bank eat a 20k loss or whatever on the difference between the remaining principle and the 104k refinanced loan?
That just seems out of character for any bank to do unless they are basically forced to do so at gunpoint…