Here we go again - debt forgiveness in adjustments

[Judge Roy Bean]

Opinions please:

Typical Countrywide borrower eligible for an adjustment on their loan to bring it into reality. BofA is offering a principal reduction of $23,000 to match the current appraised value and to reset the current interest rate (11.395%) back to the original rate (7.925%) for three years without a prepayment penalty. Again, it's a REMIC pass-through mortgage so there is no penalty for the servicer to NOT issue a 1099, but given the scrutiny of this settlement arrangement with the various Attorneys General, shouldn't borrowers assume they're going to be on the hook for not only the taxes on the $23,000 but the difference in three years of decreased interest payments as well?

I believe they should - but I also believe BofA/Countrywide isn't saying one way or the other while discussing the terms with the borrowers, and this late in the year, a lot of them don't have the time or resources to put aside several thousand dollars for anticipated taxes.

If it were ol' Bean in charge of the Treasury I'd issue a directive temporarily lifting the requirement to collect taxes on forgiven debt.

[LaVidaRoja]

If the debt is being forgiven because the borrower is insolvent, there is no income. There may be a lot of people who need to keep pretty close records on their solvency, however.

[jg]

See http://www.irs.gov/newsroom/article/0,, ... 34,00.html :

Questions and Answers on Home Foreclosure and Debt Cancellation

Update Feb. 4, 2008 — The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.

This provision applies to debt forgiven in 2007, 2008 or 2009. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

See also http://www.irs.gov/individuals/article/ ... 14,00.html

As to the change in the interest rate going forward, this is not income to the individual, imo, any more than in any other renegotiation of future income or expenses would there be any affect on the current year taxes. I do not claim a gain for my projected pay raise nor a loss for my employer not having made the promised pay raise. Only the actual amount received or paid need be considered. Unless the interest had already accrued and was currently payable but forgiven would the change in interest be cancellation of debt.

[Judge Roy Bean]

Hmmmmm....thanks to all. At least in this case there was a decline in the borrower's financial status AND an inflated original appraisal.

But, jg - the loan adjusted almost a year ago. As a result of the proposed interest change, the total outstanding debt will diminished by quite a bit more than the $23,000 in principal. But given the statutory $1M limit this isn't going to be an issue.

There are some of these that are being done to avoid litigation that may not meet either criteria.

Thanks again!

[Famspear]

As to the change in the interest rate going forward, this is not income to the individual, imo, any more than in any other renegotiation of future income or expenses would there be any affect on the current year taxes. I do not claim a gain for my projected pay raise nor a loss for my employer not having made the promised pay raise. Only the actual amount received or paid need be considered. Unless the interest had already accrued and was currently payable but forgiven would the change in interest be cancellation of debt.

Also, I would argue that even if the interest has already accrued and is currently payable, the discharge of the debt for that interest would not be INCOME from the discharge of indebtedness under 26 USC 61(a)(12) for an individual obligor who is a cash method taxpayer (which is probably 99.99999% of all individuals).

Thus, for the unpaid, accrued interest, there would be no need to even consider whether the individual is insolvent under 108(a)(1)(B), or whether the debt is "qualified principal residence indebtedness" under 108(a)(1)(E), etc.

In other words, a cash method taxpayer-obligor does not generally "accrue" an expense and its related liability (for federal income tax purposes). Instead, the expense is generally recognized (and deducted) by the cash method obligor at the time when it is actually (or constructively) paid by the obligor, not when the corresponding "accrued interest receivable" is accrued by the "accrual method" lender-obligee.

EDIT: For discharge of a liability related to a deductible expense, such as deductible home mortgage interest expense, see also 26 USC 108(e)(2). Thus, if paying the interest expense would have given rise to a deduction, the discharge of the debt for the interest is deemed (for federal income tax purposes) not to be "income" from the discharge of indebtedness. This is a somewhat narrower exception, as it applies only to liabilities related to deductible items.

[Judge Roy Bean]

Thanks again to all.