Congress Gives Mortgage Tax Relief For Xmas, But Second Homes & Cash-Out Refis Get Lumps Of Coal.
HR 3648 is a Xmas gift. Just passed by Congress it will fix part of the mortgage tax problem, retroactive to January 1, 2007. But the part of the problem it does not fix will leave many California families and investors with the same nasty problem. Prior to this law, some homeowners and investors that had their homes foreclosed, or sold them short, were taxed on the amount of their mortgages that were not covered by sale proceeds, but where the debt had been cancelled by agreement with the lender or by operation of law (see my previous article on the California Rules.) This situation was particularly harsh to people who just suffered the trauma of losing their homes and left them with a big tax bill but no cash to pay it. The old law, Internal Revenue Code section 108, offered some relief. If the debt was discharged in bankruptcy or cancelled when the taxpayer was “insolvent” the cancellation of debt was ‘excluded” from gross income. This however left former homeowners seeking bankruptcy protection or trying to prove their insolvency to the IRS-neither one a good option. The new law avoids those hassles by adding a new category of exemption ‘E’ to Section 108 as follows:
‘(E)’ the indebtedness discharged is Qualified Principal Residence Indebtedness which is discharged before January 1, 2010.
Sounds pretty good right? But then Congress added this little “Special Rule.”
“(2) QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS- For purposes of this section, the term `qualified principal residence indebtedness’ means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting `$2,000,000 ($1,000,000′ for `$1,000,000 ($500,000′ in clause (ii) thereof) with respect to the principal residence of the taxpayer.
What’s left out is Home Equity Indebtedness which is defined in section 163(h)(3)(C) as
“ any indebtedness (other than acquisition indebtedness) secured by a qualified residence to the extent the aggregate amount of such indebtedness does not exceed -
(I) the fair market value of such qualified residence, reduced by
(II) the amount of acquisition indebtedness with respect to such residence.
(ii) Limitation
Scrooge Congress also left out investors or people with second homes.
Can this really be true? Congress didn’t really do that. Did they? Well, let’s parse the Special Rule together.
“For purposes of this section,”
Meaning for the exclusions to cancellation of debt income only.
“the term `qualified principal residence indebtedness’ means”
Here comes the definition (pay attention now)…
“acquisition indebtedness”
Debt you incurred buying (note: not taking cash-out or paying down credit card debt).
“(within the meaning of section 163(h)(3)(B), applied by substituting `$2,000,000 ($1,000,000′ for `$1,000,000 ($500,000′ in clause (ii) thereof)”
Same definition that you get for your home mortgage interest deduction but increasing the principal amount to $2million or $1million when married filing separately (This is screwy. Congress is upping the amount of cancelled debt you can exclude but you would not get a home mortgage interest deduction for much of it—go figure).
“with respect to the principal residence of the taxpayer.”
This is your main home and the place where you get your mail. Not your vacation home or investment property. This is the same one you have been taking principal residence interest deductions on, so they better match you old tax returns.
That’s it!!! Nothing else in your Xmas stocking.
In California, the new law’s impact will be limited. If the loan is a second loan, and not a purchase money loan on your personal residence, the junior lender may obtain a deficiency judgment after the first forecloses so the second mortgage debt would not be “cancelled” in the first place (see my previous article on the California Rules) and no tax would apply.
Written by Ken Andrews