If you are thinking of walking away from your Los Angeles home, or doing a short sale on that home don’t automatically assume that you will not have taxes to pay on the forgiven portion of your debt.
There are laws in place that protect the distressed Los Angeles homeowner from having to pay taxes on the forgiven portion, but you need to make sure that you meet the requirements for this tax relief.
What are the requirements for tax relief on mortgage debts forgiveness?
- The Los Angeles home in question must be your primary residence. It cannot be a second home, an income property or seasonal home you occupy less than six months of the year. You will need to prove that it is your primary residence.
- The home could have been your principal residence all along, but you rented it out after you made your last payment and before foreclosure, thereby making it a rental property.
- The unpaid portion of the mortgage debt that the lender is canceling cannot have been used for anything other than on the house itself: construction or improvement costs. You cannot have taken a world cruise with the money you took out, or even helped pay your kids’ tuition.
- Mortgage tax relief is capped at $2 million for a married couple filing jointly and $1 million if filing separately.
Let’s say you financed a Los Angeles house for $800,000. During the bubble it was worth$1 million and you refinanced your Los Angeles home for $850,000. Since the loan was down to $74,000 at the time of refinancing, you took out $110,000 and did go on that world cruise, or bought the car you always wanted. Then came the crash and the house dropped to around $750,000 in value. You managed to get the lender to agree to forgive $115,000 in debt with a short sale for $735,000.
You will get tax relief on only $5,000. The $110,000 that you spent on the cruise or car doesn’t qualify for “principal residence debt” in any way, shape, or form.
Make sure to consult with you accountant before making any rash decisions.
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