There was a very interesting article published by Rueters related to the possiblity of receiving a tax break on underwater homes. All family law lawyers in Minnesota should be interested in this article.
Family law attorneys are often faced with dividing the home as a marital asset. However, it is more common in this economy that lawyers are dividing the home as a marital debt.
Furthermore, many people are underwater on their home mortgage and lawyers are forced to advise their client on how to best manage that problem. One option for divorce lawyers is to refer their clients to bankruptcy attorneys. However, lawyers and their clients need to be aware of some facts related to underwater home mortgages.
Homeowners who are underwater are often faced with deciding whether to pursue a short-sale or a foreclosure. However, ailing homeowners should be aware of the potential tax consequences of short-sales and foreclosures.
For example, the article explains this scenario:
[T]hose whose lenders cancel their debt would ordinarily face the tax man, because cancellation of debt, including mortgage reduction, is generally taxable. That means if you get your mortgage reduced by $100,000 and you’re in the 28 percent tax bracket, you’d owe $28,000 in federal taxes on the “income” you received when your debt was forgiven.
Typically, the only way to avoid those taxes is to declare bankruptcy or to claim insolvency, which does not require a bankruptcy filing but still requires that your debts outweigh your assets.
. . .
A special federal tax break to help ailing homeowners, put in place in 2007, allows them to exclude up to $2 million in forgiven mortgage debt from their income. To qualify, that debt has to be for your primary home — sorry, no vacation homes or investment properties.
With the tax break slated to expire in nine months, if you’re currently sinking under the weight of your home, there’s a reason to move quickly. No one can accurately foresee whether the provision will be renewed by Congress, and dealing with underwater real estate takes time.
As the article points out, family law attorneys and their clients need to be aware of the potential federal tax breaks which could be associated with a short-sale or a home foreclosure. This could be a key negotiating point for anybody trying to settle a divorce.
Furthermore, the article explains that current federal law will allow ailing homeowners to exclude up to $2 million in forgiven mortgage debt; however, state governments may not allow such a tax break. In other words, just because the federal government allows the exclusion, ailing homeowners could still be taxed by the state government where they live.
Obviously, the tax effects of forgiven mortgage debt is a important issue for all ailing homeowners and their lawyers to consider.
See Tax breaks for underwater homeowners, Reuters, April 2, 2012.
-This post was written by Joseph M. Flanders, and Apple Valley, MN lawyer.