I have received many recent questions about whether Mortgage Forgiveness Debt Relief Act (“Debt Relief Act”) would be renewed before its extension on December 31, 2012.

The Debt Relief Act spares homeowners who receive debt cancellation following foreclosure, short sale or loan modification from paying federal income tax on the forgiven debt.

Under the federal tax code, all debt forgiveness is taxed as ordinary income. Without the Debt Relief Act, a homeowner who owes $500,000.00 and short sales his home for $200,000.00 will owe an ordinary income tax on the $300,000.00 difference.

The Senate Finance committee recently approved a bipartisan bill which extends the current Debt Relief Act through December 31, 2013. Limit is $2 million in debt cancellation for a married couple filing jointly and $1 million for single filers.

Although originally doubtful that the current fractured committee could agree on anything, the extension was approved thanks to significant lobbying by the National Association of Realtors®.

The extension is expected to move to the full senate for approval after the election. All indications are that it will pass and the Debt Relief Act will remain law through 2013.

Your clients should seek counsel from their CPA for a full explanation.


Homeowners who sell their primary residence can exclude up to $500,000.00 in gain from income tax. This rule has become known as the “2 in 5 rule” whereby the exemption applies if a homeowner used any property as his “primary residence” during 2 in the last 5 years.

The rule changed upon passage of the Housing Assistance Act of 2008 (H.R. 3221). Under the so-called Assistance Act, the amount of profits from the sale of a residence that can be excluded is now based upon the “percentage” of time that the residence was used as a primary residence.

A determination of the “percentage” is based upon an allocation of qualifying and non-qualifying use of the residence. Qualifying use is when the property is being used as a “primary residence” by either one or both spouses.

Non-qualifying use is when the property is being used as a rental, second home, vacation home or left vacant. For the purpose of calculating the tax, a non-qualifying use is any period that the property is not used as a primary residence on or after January 1, 2009. Non-qualifying use prior to January 1, 2009, is disregarded.

For example, assume that a married couple purchased a house as their primary residence on January 1, 2009. They moved out of the house and rent it out for two years between January 1, 2001 and January 1, 2013. They sell the house on January 1, 2013.

Under this example, the couple owned the house for four years. Because they rented it for two out of the four years of ownership, they only get 50% of the exemption. In other words, they get only $250,000.00 (not $500,000.00) of the exemption (50% x $500,000.00 = $250,000.00).

The amount of available exemption under the new rules is the “number of years/months of non-qualifying use = number of years/months of ownership”.

The take-home message is that once owners chose to rent their property, they will never qualify for the entire $250,000.00/$500,000.00 exemption.

Your clients should seek counsel from their CPA for a full explanation.


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