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October 03, 2007

The tax law has long considered debt forgiveness to be taxable income, for obvious reasons. If you borrow money, and don't have to pay it back, it looks a lot like income. That's just as true whether you still have the borrowed funds, squandered them at the casino, or lost them gambling on the housing market.

The tax law also has an escape hatch if you are really in a bad way financially. Debt forgiveness income isn't taxable to the extent you are insolvent - that is, to the extent your liabilities exceed what your assets are worth.

Now Congress is preparing a new escape hatch. Under legislation that has cleared the House Ways and Means Committee, (H.R. 3648) you can have up to $2 million in housing debt forgiven tax-free. As this will only affect those whose net worth exceeds the amount of debt forgiven, it has the effect of providing a new tax break for people with net worths in 7 figures.

To pay for the bill, Congress proposes to restrict the home sale exclusion for houses that have been used as vacation homes - a provision we discussed here.

So - to pay for a tax break for deadbeats with a net worth of $2 million or more, Congress proposes to remove a tax break for people who actually pay off their loans. Thank goodness we have Congress to look out for the little guy.

Tax Notes has more ($link).

If Ways and Means has its way, you can have the entire purchase price of this fine Des Moines home, listed at $1.95 million, given to you as debt forgiveness tax-free.

UPDATE: President Bush also wants to help the mortgaged millionaires.

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Hey, why no negative. I don't sleep at night worrying about the tax I would owe if my four houses are forclosed on because they are all worth less than what I owe. Also, I've lost hundreds of thousands of dollars on these four homes. There is no tax break for that! The new law: will it cover my four houses even though they are not principal residences? Thanks

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