Homeowners who lost their home to foreclosure in 2015 were faced with either of two bad financial outcomes if the home was worth less than the mortgage balance at the time of the foreclosure sale. Either the bank pursued a deficiency judgment or the bank waived the deficiency and the IRS taxed the homeowner for imputed income on the amount of the deficiency forgiveness.
When the mortgage meltdown started in 2007 Congress passed a law eliminating imputed income from deficiency waivers. The law protected from large imputed tax liability the millions of homeowners who lost upside down homes during the real estate recession. The tax waiver expired in 2014. Since then, many people whose homes were foreclosed had to pay tax on imputed income from deficiency forgiveness. A significant percentage of those affected chose to file bankruptcy. Insolvent homeowners are not subject to imputed tax, and bankruptcy certifies the debtor’s insolvency. Many of my clients over the past two years complained that it was unfair that homeowners who walked away from upside down homes early in the recession were protected from adverse tax consequences while those who tried to hold on to their homes but eventually lost their homes to foreclosure in the past two years had to deal with potential imputed income tax liability.
Congress has reinstated the exemption from imputed income for people who lost their upside down primary residence to a foreclosure and were not pursued for a deficiency judgment. The budget and spending bill enacted in December, 2015, reinstated the tax exemption retroactive to January 1, 2015. The protection extends through 2016. Moreover, Furthermore, as long as a deficiency forgiveness is drafted in 2016, the tax exemption will still apply through 2017. This is good news for homeowners who anticipated a large 2015 tax liability from mortgage forgiveness, but it is not good news for those people who had decided bankruptcy was necessary to avoid the tax and had to file bankruptcy as a result.