Taxation & Estate Planning

YEAR END TAX LAW CHANGES

By Charles Rubin

A number of interesting year-end tax law changes were recently enacted. We will review a few of them in the coming postings. Let's start with two - AMT relief and mortgage discharge relief.

A. Alternative minimum tax exemptions have been increased for 2007, instead of being decreased as required under prior law. The exemption is increased to $66,250 (up from $62,550 in 2006) for married couples filing a joint return and surviving spouses, to $44,350 (up from $42,500 in 2006) for an individual who isn't married or a surviving spouse, and to $33,125 (up from $31,275 in 2006) for married individuals filing separate returns.

B. In recognition of the real estate debt problems many taxpayers are facing, a relief provision has been added for discharge of indebtedness of income relating to principal residences. Normally, if a lender relieves a borrower from having to pay off debt, the borrower incurs taxable income. Thus, for example, assume a taxpayer owns a house with a $300,000 mortgage. Due to increases under an adjustable mortgage, the taxpayer can no longer pay the mortgage. Due to decline in values, the house is only worth $250,000. The lender forecloses on the residence and acquires ownership to the residence, and does not pursue the borrower for the $50,000 loss it suffers due to the difference between the $300,000 loan amount and the $250,000 value of the house. Under normal circumstances, the taxpayer would incur $50,000 of ordinary income, unless the taxpayer was otherwise insolvent or other limited exceptions to discharge income applied under the Internal Revenue Code.

Under the new rules, if the discharge occurs before 2010, the indebtedness was incurred to acquire, construct, or substantially improve the individual's principal residence, and is secured by the residence, no discharge of indebtedness income will arise. The new rules are limited to $2 million of such "acquisition indebtedness." The exclusion rule will not apply to second homes, vacation homes, business property, or investment property, since these properties aren't the taxpayer's principal residence. It also will not apply to discharges of second mortgages or home equity loans, unless the loan proceeds were used to acquire, construct, or substantially improve the taxpayer's principal residence.

Note that a foreclosure is not required - a restructuring of a debt that involves a reduction in debt will also be covered, if the above requirements are met.

Full post as published by Rubin on Tax on December 28, 2007 (boomark / email).