If a foreclosure is in your future, you should be aware of certain tax issues. As part of the CARES Act, Congress provided temporary relief for homeowners with federally backed mortgages who were financially impacted by COVID-19. For those unable to keep up with their home mortgage payments, the relief provides mortgage forbearance. Also this provided a temporary stop against foreclosures through August 31, 2020.
As the pandemic continues to wreak havoc on people’s finances, the FHFA said that Fannie Mae and Freddie Mac will extend foreclosure moratoriums to December 31, 2020 and perhaps longer.
Unable to Make Mortgage Payments? You have Options.
If, because of the pandemic, you cannot make your payments you have some options. First, you should contact your lender to request forbearance for your loan payments. Your lender may allow temporarily lower mortgage payments. They might even pause payments altogether, helping you deal with the current financial hardship.
Along with your financial hardship, you probably should consider the potential tax and financial ramifications.
Forbearance – How It Effects Taxes
Whether the forbearance reduces or pauses your payments your home mortgage interest will be reduced. This is the largest tax deduction for most taxpayers. However, that deduction may not make any difference in your taxes if your income has been substantially reduced.
IRA Withdrawal
Although most financial gurus advise not tapping your retirement funds for non-retirement purposes, the CARES Act eliminated penalties on up to $100,000 of withdrawals from IRAs and qualified plans. In addition, the CARES Act also now allows the tax on the withdrawals to be spread over a 3-year period. And finally, the funds can be re-contributed to your IRA within the 3-year period. While these funds could be used to make mortgage payments, that may not be the best solution. For example, you may not want to go this route if the home will ultimately go into foreclosure.
How Can I Qualify For Help?
To be eligible for the special provisions of these distributions, you, your spouse or dependent must have been diagnosed with the COVID-19 by a test approved by the CDC. Or have experienced adverse financial consequences as a result of the coronavirus. These other examples might include:
- being quarantined;
- if you are furloughed, laid off or having work hours reduced;
- being unable to work due to lack of child care;
- closing or reducing hours of a business owned or operated due to the virus or disease;
- incurring a reduction in pay (or self-employment income); or
- having a job offer rescinded or start date for a job delayed.
Debt Relief And Your Taxes
With the downturn in the economy, many taxpayers find themselves in debt. Some of this debt is completely overwhelming, and taxpayers settle their debts for less than what is owed. Other taypayers have had their property repossessed or foreclosed upon. All of these actions result in the individual being relieved of debt.
HOWEVER, in the eyes of the tax code, debt relief is treated as income. This means, the banks and lenders are required to issue a Form 1099-C reporting the debt relief income attributable to the taxpayer. That debt relief income is taxable to the taxpayer unless they qualify for relief provided under other provisions of the tax code.
Provisions for Taxpayers
Insolvency Exclusion
One of those provisions is the insolvency exclusion. A taxpayer is insolvent to the extent the taxpayer’s debts exceed their assets at the time of the debt relief.
Principal Residence Acquisition Debt Relief Exclusion
Another provision is the principal residence acquisition debt relief exclusion. This exclusion applies through 2020. However, that exclusion will generally not provide any benefit for homes going into foreclosure due to COVID-19, since those foreclosures will take place in 2021. (Unless Congress extends the exclusion, as they’ve done in the past).
There are other options that may pertain to you, with certain circumstances. If you wish to tax strategize, please give us a call at (360) 778-2901.
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