Upside Down or Underwater Mortgages
by
Edi Alvarez, MSc, CFP®
October 2009
Being “upside down” or “underwater” on your mortgage occurs when
you owe more on the mortgage than the dwelling is worth in the current market.
The new amendments to the tax code can help some, but not all, underwater
mortgages. IRC section 61(a)(12) requires that you
report all forgiven debts on your 1040 as if it were income.
It is important that you note if you fall within the new changes of
section 108. Section 108 normally specifies several hedged exceptions, including
bankruptcies (Chapter 11) and insolvencies (liabilities exceed assets). It now
includes “mods,” foreclosures, deeds in lieu of
foreclosure, and short sales.
They were recently extended to 2009 (through the Mortgage Forgiveness
Debt Relief Act) and more recently until 2012 (through the Emergency Economic
Stabilization Act).
To avoid the normal taxation of forgivable
loans you must satisfy the following:
1.
The
debt cancelled cannot exceed $2 million
2.
The
security for the mortgage has to be the debtor’s principal residence
3.
The debt must derive from the purchase,
construction or improvements to that same residence
There is NO relief for any other home equity loans or cash-out
refinancing. Surprisingly, it can not be used for basic repairs that did not add
value to the home.
You should be careful since the fine print stipulates that this
relief will not apply if debt is for a second
home or rental property – in other words, MAKE SURE IT QUALIFIES AS A PRINCIPAL
RESIDENCE.
How you determine if your property is indeed a principal residence?
Indicators can include, but are not limited to: the proportion of the year you
live at that address (as compared to other residences), whether it is your place
of employment or where your family is housed full-time, if it is your primary
mailing address used on a tax return, your driver’s license address, or your
auto registration address.
You will have to pay taxes on forgiven debt from a second home,
rental or business properties, credit cards and car loans unless you
qualify under other relief, such as insolvency.
Always consult a tax planning account or
tax preparer. Be prepared to provide evidence for principal residence and how
you used equity loans and/or cash-out refinancing.
© 2009 Edi Alvarez. All rights
reserved.