H.R. 3648: Mortgage Forgiveness Debt Relief Act of 2007

President Bush signed into law a new measure giving tax breaks to homeowners who have mortgage debt forgiven. Under preexisting law, the debt forgiven by a lender, such as for short sales and refinances, was generally taxable to the borrower as debt discharge income. With the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer does not have to pay federal income tax on debt forgiven for a loan secured by a qualified principal residence. This tax break applies to debts discharged from January 1, 2007 to December 31, 2009. Qualified principal residence indebtedness is debt incurred in acquiring, constructing, or substantially improving the residence (up to $2 million for refinances). For purposes of calculating capital gains, any debts discharged excluded from income under the new law must be subtracted from the basis of the taxpayer’s principal residence (but not below zero). However, taxpayers may generally exclude from capital gains income up to $250,000 (or $500,000 for married couples filing jointly) for properties owned and used as their principal residence for at least two of the last five years. For a copy of the Mortgage Forgiveness Debt Relief Act of 2007, go to http://www.govtrack.us/congress/bill.xpd?bill=h110-3648 With the new tax break for mortgage debt forgiveness law the government is limiting the capital gains exclusion. Currently, an individual could have lived in a principal residence for two years, and sell using the exclusion, move into their vacation home for two years, and sell using the exclusion, with the end result being that you could have a tax free gain of $500,000 THREE TIMES in six years. Now, for properties acquired and used as a second home starting next year, and later converted to principal residence for a time and then sold, only the period when the property was used as a principal residence will count toward the capital-gain-exclusion computation. The amount of the gain that’s proportional to the period when it was not a principal residence would be taxable.

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