Tax Law Changes That Impact Homeowners

Tax Law Changes That Impact Homeowners
With foreclosure rates at an all time high, new tax law was
passed at the end of 2007 to help homeowners avoid
unmanageable income tax debt due to income created from a
foreclosure. The new law also covers mortgage
renegotiations and other real estate related benefits.

How is income created from a foreclosure? Here is a common
scenario:

A lender forecloses on a property and then sells the
property for less than the outstanding mortgage balance.
There still remains an unpaid mortgage debt, which is the
difference between the outstanding mortgage balance and the
sales price. What usually happens next is the lender
forgives the unpaid mortgage balance.

Before the new tax law, the unpaid mortgage balance was
considered taxable income leaving the homeowner with an
income tax bill.

After the new tax law, the unpaid mortgage balance is
excluded from taxable income up to $2 million.

What is a mortgage renegotiation? Before starting the
foreclosure process, a lender typically performs a
cost-benefit analysis of foreclosing on a property. The
result may be that the foreclosure is not in the lender's
best interest, which isn't uncommon since the typical
foreclosure nets the lender only about 60 cents on the
dollar. In this case, the lender may renegotiate the terms
of the mortgage to get to a lower monthly payment for the
homeowner.

For example, one renegotiation workout plan organized by
the Bush Administration and a group of lenders would bypass
adjustable rate resets for up to five years. This type of
renegotiation would typically result in forgiveness of
indebtedness income creating taxable income to the
homeowner if it were not for the new law.

What type of debt qualifies for the exclusion? The new law
applies to debt incurred for the acquisition, construction
or substantial improvement of the principal residence of
the taxpayer and is secured by the residence. It also
includes refinancing of such debt to the extent that
refinancing does not exceed the amount of the original
indebtedness.

What do homeowners need to watch out for? Homeowners who
did "cash-out" refinancing and did not put the funds back
into the home but, instead, used the funds to pay off
credit card debt, tuition, medical expenses, or other
expenditures. The "cash-out" amount is indebtedness income
and fully taxable unless other exceptions are met.

What qualifies as a principal residence? A principal
residence is the one in which the taxpayer lives most of
the time. However, the determination of a taxpayer's
principal residence is based on "all the facts and
circumstances." The definition is the same as the home
sale gain exclusion.

This rules out vacation homes, second residences and rental
properties, even if the properties were purchased with
equity from the taxpayer's principal residence.

When is the new law effective? This special relief is
available for three years beginning January 1, 2007, and
ending December 31, 2009.

What other real estate related benefits are included in the
new tax law?

Mortgage Insurance Deduction. The new law extends the
mortgage insurance deduction to amounts paid or accrued
after December 31, 2007, but only with respect to contracts
entered into after December 31, 2006, or prior to January
1, 2011.

Survivor's Home Sale Exclusion The new law extends the time
in which a surviving spouse may use the married filing
joint $500,000 home sale gain exclusion before being
treated as a single individual entitled only to a $250,000
exclusion. Before the new tax law, a surviving spouse was
could use the $500,000 exclusion only to the extent he or
she could file a joint return with the deceased spouse's
estate, which is only in the tax year the spouse dies.

Starting January 1, 2008, the surviving spouse can use the
$500,000 gain exclusion up to two years following the date
of death of the spouse.

What's the catch? As you have read, this new tax law
contains major tax reductions, which are offset by several
tax increases included in the new law. These increases
include:

An increase in the failure to file penalty for partnerships
from $50 to $85 per partner per month, up to 12 months

A new failure to file penalty for S corporations of $85 per
S shareholder per month, up to 12 months

Increases in corporate estimated tax payments for
corporations with $1 billion-plus assets, by 1.5 percent to
117.25 percent for payments due in July, August and
September 2012.

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Tom Wheelwright is not only the founder and CEO of
Provision, but he is the creative force behind Provision
Wealth Strategists. In addition to his management
responsibilities, Tom likes to coach clients on wealth,
business, and tax strategies. Along with his frequent
seminars on these strategies, Tom is an adjunct professor
in the Masters of Tax program at Arizona State University.
For more information, visit
http://www.provisionwealth.com.com .