If you're going to walk away from your upside down mortgage, do it in 2012.
Under current law, homeowners may engage in a short sale or foreclosure transaction without tax consequences so long as the lender officially releases the debt. This is the result of the Mortgage Debt Relief Act of 2007 which allows taxpayers to exclude income from the discharge of debt on their principal residence.
But be aware of a planned change in the law. Effective January 1, 2013, debt forgiven in connection with a short sale or foreclosure of a primary residence will be taxable for federal purposes. This is a big deal.
For example, this means that a short sale of a home for $25,000 less than the outstanding mortgage amount would subject the seller to taxes on $25,000 of income. Homeowners in the 35 percent tax bracket would owe $8,750; homeowners in the 33 percent tax bracket would owe $8,250; homeowners in the 25 percent tax bracket would owe Homeowners in the 28 percent tax bracket would owe $7,000; homeowners in the 25 percent tax bracket would owe $6,250; homeowners in the 15 percent tax bracket would owe $3,750; and homeowners in the 10 percent tax bracket would owe $2,500.
Short sales can take a long time, so homeowners who want to short sell their homes during 2012 before the law change takes effect would be well-advised to begin the process now.
