Tax breaks for homeowners survive in 2013

In our example, if Jenny sells the house for $800,000, her gain will be $700,000. Her tax bracket will determine how much capital gains tax she will have to pay. Under the new law, taxpayers who are single and earn more than $400,000 (or married and earn more than $450,000) have to pay 20 percent capital gains tax. For incomes below those threshholds, the 15 percent capital gains tax is still the law. So, for example, if Jenny is in the 25-to-35 percent tax bracket, she will pay 15 percent capital gains tax on the first $400,000 (or $450,000 if married) and 20 percent on the balance.

The moral of that story: In most situations, parents should not give their children the family house but should either sell it to them or let them inherit it on their death.

Congress also preserved a provision helping underwater homeowners, extending the cancellation of qualified mortgage debt through the end of this year. If your home is foreclosed upon or sold in a short sale, your outstanding balance in most cases will be canceled.

To oversimplify: In most situations where a debt is canceled, you will have to pay tax on the amount that was forgiven, even though it’s not money that you actually received.

For years, tax law allowed only a few exclusions, such as on debt canceled in Title 11 bankruptcy or during insolvency. Then in 2007, faced with a growing volume of foreclosures and short sales, Congress passed the Mortgage Debt Relief Act, now known as the Mortgage Forgiveness Debt Relief Act. In general, it allows homeowners to exclude as much as $2 million ($1 million if married and filing separately) of the cancellation or forgiveness of debt on their principal residence. The law had been scheduled to expire at the end of 2012.

How do you know how much of your debt has been canceled or forgiven? If the debt is $600 or more, your lender is required to send you, by Feb. 2 of each year, Form 1099C (Cancellation of Debt), which must state the amount of the debt forgiven as well as the fair market value of any property given up through foreclosure or a short sale.

Homeowners should beware: Some lenders — even if they tell you and the IRS that your debt has been canceled — still try to collect any deficiency, often by turning the matter over to a debt collection company. This has become especially true involving short sales. If you are involved in such a short sale, make sure you know all the terms and conditions before you complete the deal.

For more information, go to www.irs.gov and type “cancellation of debt” in the search field. Also, Publication 4681, titled “Canceled Debts, Foreclosures, Repossessions, and Abandonments,” may be helpful.

Now is the time to start doing your homework, pulling your books and records together and preparing Form 1040. The IRS says that will take taxpayers an average of 22 hours and will cost approximate ly $290. Good luck!

Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.