New Rules Ease the Sting of Mortgages
The Mortgage Forgiveness Debt Relief Act of 2007, which is effective from Jan. 1, 2007, through Dec. 31, 2009, is expected to provide more than $600 million of tax relief to people whose mortgages on their principal residences are foreclosed.
Sidney Kess, a New York tax lawyer and certified public accountant, gave this example of how the law works: Suppose a buyer defaults on a $220,000 mortgage. The bank forecloses and sells the house in today’s battered market for $180,000. The $40,000 of remaining debt is discharged. Under previous law, the $40,000 was considered income and was subject to taxation. Under this law, the tax obligation is forgiven.
The law also extends a deduction for mortgage insurance that was authorized for 2007 by the Tax Relief and Health Care Act of 2006. Barbara Weltman, a tax lawyer in Millwood, N.Y., who is also a contributing editor of “J. K. Lasser’s Your Income Tax 2008″ (John Wiley & Sons, 2007, $17.95), said the deduction would be significant for many young homebuyers who put little or no money down, especially when they might be facing rising payments on adjustable-rate mortgages.
Buyers who put down less than 20 percent when buying their home are required to buy the insurance to protect not themselves but the primary lender, she noted. Both private sources and government agencies like the Federal Housing Administration and the Department of Veterans Affairs offer this insurance.
The insurance can cost several hundred dollars a year, or even more than $1,000. The full deduction is available to people whose adjusted gross income is $100,000 or less; it phases out when income reaches $110,000. There is no tax relief, however, for people who stretched to buy the nicest home they could afford in recent years and sold at a loss last year. “There’s no deduction at all for a loss on a principal residence,” said Julian Block, a tax lawyer in Larchmont, N.Y.
Investment real estate, like other assets, is subject to tax rules governing capital gains and capital losses, but a personal residence is different.
Mr. Block pointed to the example of people who had made large down payments - upwards of $80,000 in some cases - on retirement homes being built in South Carolina by Levitt & Sons, the big home builder that filed for Chapter 11 bankruptcy last November.
Some may eventually get homes that are worth less than their contractual price; others expect to lose their entire deposit; but none will get tax relief on their losses, he said.
Experts also offered advice on various other considerations for taxpayers this year:
PROFESSIONAL PREPARATION “People will find that preparers are fussier about data this year,” said Bill Fleming, a tax director in the private client services group of PricewaterhouseCoopers in Hartford. The reason is that the Small Business and Work Opportunity Tax Act of 2007 calls for stiff penalties on professional preparers who take an “unreasonable position” on a return or who are guilty of willful or reckless conduct.
As a result, accountants are likely to want to see the documents that back up a client’s deduction claim, he said. For mortgage interest and real estate taxes, for example, that would be the 1098 form issued by the bank or financial institution. “The I.R.S. has to be strict, so we have to be strict, too,” he said.
Mr. Fleming cautions taxpayers, whether do-it-yourselfers or those who turn to professionals, to double-check every W-2 and 1099 form when it arrives and to contact the issuer if there are any errors, and also to be careful in collecting their own data and organizing it.
“We’re seeing more penalties imposed on accidental errors, carelessness,” he said. “The primary cause of errors is moving money around, transferring accounts” and losing track of perhaps significant interest, he added.
In any event, clients with well-organized records will have to pay less to their accountants than do people with disorganized records and missing papers. “The less time we spend on it, the less we charge,” he said.
CHALLENGING THE I.R.S. Of course, the Internal Revenue Service may take an erroneous position, too. Mark Luscombe, a lawyer and accountant who is principal federal tax analyst for CCH, which publishes books and software for tax professionals, said, “If you look at the criteria in the law and feel you are qualified” in taking a particular position “and the I.R.S. denies it, don’t take that as the last answer.”
The I.R.S. has usually prevailed when litigating cases in tax court, he said, but in the past year courts have “slapped the hands of the I.R.S.” more often than usual. A number of cases involving what the law calls “innocent spouse” relief, for example, were resolved in favor of taxpayers. Normally, if a husband and wife file jointly, each is liable for the taxes owed, but the law grants an exception to an “innocent spouse,” who can prove that he or she was the victim of a deceitful spouse and did not know of unreported income or lies on a tax return.
In another setback for the I.R.S., the United States Court of Appeals for the District of Columbia Circuit held that the I.R.S. was required to disclose e-mail messages containing legal advice sent to field personnel by lawyers in the I.R.S. Office of the Chief Counsel. Mr. Luscombe said the I.R.S. had “a very long history of trying to keep internal communications secret.”
FAMILY BUSINESSES Beginning with 2007 returns, if a couple own a business, both husband and wife may file a Schedule C as a sole proprietor with their tax return, with each reporting his or her share of the income and paying self-employment tax, Mr. Kess said.
Previously they were required to file a partnership return, but many people did not bother, choosing instead to let one partner claim the business and file Schedule C. But when it comes time to file for Social Security and Medicare benefits, that could prove costly to the partner who did not report any of the income, especially in cases of divorce.
REFUNDABLE A.M.T. CREDITS Many people who had tax credits resulting from the exercise of incentive stock options in the dot-com heyday have been unable to claim them in recent years because they were liable for the alternative minimum tax. On 2007 returns, they will be able to claim up to $5,000 of those credits, Mr. Luscombe said, adding, “What I’m hearing is that it is token relief, not the relief they had hoped for.”
RECENT GRADUATES Although the earned income credit is intended for the working poor, some 2007 graduates who landed their first jobs late in the year may be eligible for it, Mr. Fleming said. Generally the credit may be available to a single filer whose adjusted gross income for 2007 is below $12,590, who cannot be claimed as a dependent on another person’s return and whose income does not include more than $2,900 of investment income.
SUPPORT OF OLDER RELATIVES People who are helping to support older relatives may want to consider how to do so most effectively under the tax laws, Ms. Weltman said. For 2008 through 2010, people in the two lowest tax brackets, 10 percent and 15 percent, will not be liable for any tax on long-term capital gains.
That would make it advantageous to give an appreciated security to an elderly relative who has modest income, rather than selling it and paying capital gains tax. The relative can sell it with no tax liability, Ms. Weltman said, though she cautioned, “Be sure the gain does not push her into a higher bracket.”
By JAN M. ROSEN
