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Struggling homeowners consider Chapter 13, tax breaks

For those in California who are struggling to make ends meet, finding a way to keep their home is often a top priority. Some are considering accepting principal reductions offered by their mortgage lender, in an effort to make their house payments more affordable. However, it is important to understand the tax ramifications of accepting such a deal. For some, filing for Chapter 13 bankruptcy may offer a better path to debt relief, while also allowing individuals to keep their home.

A recent $16 million settlement between the Justice Department and Bank of America is expected to lead to offers of mortgage principal write-downs for homeowners who owe more on their home than the property is currently worth. However, for those who accept these deals, a serious tax burden will result. Any amount forgiven by the lender will be reported to the IRS as income received by the borrower. Those homeowners will then be taxed on that amount as if it were regular income.

Congress placed a temporary hold on these tax consequences back in 2007, but the provisions of that hold expired last December. Many are hoping that Congress will extend the tax break, which would make it easier for borrowers to accept the upcoming relief offers. However, in order for those who have already accepted principal reduction offers, any extension would also have to be applied retroactively in order to avoid increased taxation.

For many in California, the ability to avoid a serious tax hit could make a principal reduction offer worth consideration. As it stands currently, however, filing for Chapter 13 bankruptcy may be a better solution. Doing so would allow borrowers to restructure their debt in a manner that eases financial strain, while retaining their home. In light of recent Congressional movement, or lack thereof, Chapter 13 may offer the best path toward lasting debt relief.

Source: Los Angeles Times, "Will Congress renew tax relief for homeowners' debt forgiveness?", Kenneth R. Harney, Sept. 14, 2014

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