I’ve written before that property owners who negotiate a waiver of deficiency judgment on property other than their homestead face potential income tax for forgiveness of debt unless they can prove they were insolvent at time of the debt waiver. I’ve also commented that some attorneys have stated they could arrange to avoid this tax trap.
A New York attorney, Hilton Wiener, wrote me an email to explain how he helps his clients avoid income tax liability while achieving debt relief. He explains that when a case between a property owner and a lender involves a bona fide dispute the settlement of the dispute that involves release of the owner’s personal liability on the note is not considered a release of debt. The settlement of a bona fide dispute does not cause income tax liability for release of debt. He says this rule is well-researched and will prevail in tax court. One example of a dispute is a property owner’s counter claim against the bank for violation of federal lending regulations; another is the claim that the lender broke a promise to lend money or revise loan terms.
Mr. Wiener stresses that a property owner facing foreclosure cannot make up a frivolous claim against the bank.
This issue is more important because of the expiration of the Mortgage Debt Relief Act. (“the Act”). The Act, enacted in 2007, stated that people would not face tax liability for release of mortgage debt related to their primary residence. The Act expired in December 2013, so all property owners are facing potential income tax liability from a release of personal liability on their mortgages.