Forgiven debt can send IRS calling

I felt that this is important to write about because so many people don’t realize that forgiven debt is taxable income.  So what is forgiven debt and how does it relate to real estate?  Let’s say that you short sale your home in order because you have to move and the house isn’t worth as much as it used to be and you can’t get for it what you still owe on the loan.  Say you owe $250,000 and you do a short sale for $200,000.  That $50,000 difference is forgiven debt.  You don’t owe it anymore and the bank has taken the loss for you.  Well, in walks the IRS.  They believe that forgiven debt is taxable income.  Whoa!  You lost money, you’re out of your house, and now you owe the IRS?

Yes.  It’s that simple.  However, in 2007, Congress created legislation to avoid this in some circumstances.  As long as the loan was used to purchase or improve the home owner’s primary residence, the IRS had to exclude up to $2 million of that forgiven debt from taxes.  So that’s the good news.  But beware: This legislation is currently set to expire in 2012.  So if now begins the time that you’re starting to fall behind on payments, unless the legislation is renewed, you could owe on it in 2012 or further into the future.  And if the bank sends you a tax form 1099-C because of forgiven debt, it’s crucial that you inform the IRS that you’re eligible for this Congress-enacted exclusion.  Otherwise, they can tax you for it.

It’s also important to realize what else is considered taxable debt and IS NOT included in the exclusion.  This debt will be taxable:

1. Credit card debt.  If you negotiate with your card company to reduce the amount you owe, any amount that gets forgiven is taxable.

2. Mortgage debt from a second home.  The exclusion only applies to your primary residence.  If you lose a vacation house, income property, or second home because of foreclosure, the difference is taxable.

If you’re really in a bind, you can choose to file for bankruptcy.  Any debt that’s forgiven that stems from a bankruptcy is not taxable.  If you have further questions, please contact a CPA to guide you through that and any other tax process.  I can be reached via my Web site.

Understanding your property tax bill

For those of you living in Cook County, you’ve probably received your 2008 tax bill over the last few weeks.  I wanted to touch on a couple of points relating to this.  Most of you probably figure that given the recession and property values going down, you’re shocked to see your tax bill go up!  So how can this be?

taxesThere are multiple reasons.  First of all, this bill represents the 2008 tax year.  So the bill for the assessment done reflected home values as of January 1, 2008, which was before the housing market completely dropped.  All Illinois property taxes are paid in arrears.  That means we pay this year for what happened last year.  We won’t pay for this year until next year.  Better than prepaying, right?

Also, this bill was based on your home’s assessed value (as I mentioned before).  When home values were on the rise earlier in the decade, the assessments went up, too.  When this happened, lawmakers in Springfield gave every county the authority to impose a ceiling on assessment increases.  Well, Cook County was the only county to take advantage of this (Sorry, Lake!)  But the ceilings are slowly being phased out and the assessments are now allowed to begin to increase again.

Because of the housing crisis, it is possible that assessments will start to go down.  However, you will not see that reflected until you receive your bill in 2010 for the 2009 tax year.   There is a chance that even if your assessment does go down next year, your bill could still go up.  WHY?  Well, aside from being taxed on your value, you have to take into account any recent tax hike referendums, what level of financial support is going to local schools, and general assessments across a community.  (Visit your local town/village’s Web site for more complete information.)

So you’re probably wondering if you can appeal.  Unfortunately, you can’t.  If there is a mathematical error on the bill, you absolutely can.  But it’s too late to appeal your assessments for this bill.  Lake County residents have 30 days from receiving their assessment to appeal their assessments for 2009.  Visit Lake County’s site for more information on how to do this.

If you don’t pay your taxes, just like your mortgage, your house can be taken away from you and auctioned off at a sheriff’s sale.  But make sure to do your research to determine if you are being fairly taxed.  If you have any more questions, be sure to visit me online.