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Expiring Law Could Add Tax Bill After Personal Bankruptcy

Posted on February 10th, 2014

Arizona residents who experience unexpected life changes such as unemployment or illness may find themselves struggling to pay mortgages, medical expenses and credit card debt. By utilizing personal bankruptcy, they can resolve their financial challenges. However, he expiration of the federal Mortgage Fairness Debt Relief Act at the end of 2012 could add an additional tax burden on people who eliminate debt in a Chapter 7 bankruptcy.


The IRS treats forgiven debt as income subject to taxation. Congress passed the Mortgage Fairness Debt Relief Act in 2007 to aid homeowners who were struggling with debt by excluding mortgage debt cancelled through short sales used to stop foreclosure or through foreclosure itself from federal taxation as income. The exclusion applied even when the mortgage money was not used to purchase the mortgaged property.


The legislation had little impact in a non-recourse state such as Arizona where a homeowner is not personally liable to a mortgage lender after the bank takes the house. As long as the homeowner used the mortgage money to purchase the home, homeowners in non-recourse states were not subject to taxation by the IRS even prior to the 2007 legislation.


The financial challenge confronting Arizona property owners if the Mortgage Fairness Debt Relief Act ends concerns mortgages where the money was not used to purchase the home. A short sale or  foreclosure that eliminates all or part of a debt that was not used to purchase the mortgaged property may subject the person who sought debt relief with a bill from the IRS.

  However, a bankruptcy would prevent the IRS from sending a cancellation of debt bill to the person seeking relief.  Hence, this is just another reason why you should speak with a qualified bankruptcy lawyer to work out all of your options.


Personal bankruptcy can stop repossession, eliminate debt, and stop foreclosure for those individuals experiencing financial challenges. A bankruptcy attorney can be consulted about the effect the uncertain future of the Mortgage Fairness Debt Relief Act may have on homeowners who are filing for bankruptcy.


Source: InMaricopa.com, “Expiring debt relief could impact short-sale market,” Christina Sampson, Aug. 15, 2012

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