Homeownership offers lots of tax breaks. But the crash of the housing market produced a new tax problem for some homeowners. When their homes went into foreclosure, many ended up owing tax on the amount of their debt that was forgiven by the lender who took over the property.
Those folks got tax relief from those taxes thanks to the Mortgage Forgiveness Debt Relief Act of 2007. That law allowed many taxpayers to exclude from their income, thereby making it not taxable, up to $2 million in foreclosure-related mortgage debt.
The foreclosure tax debt relief was extended through 2012 as part of the Emergency Economic Stabilization Act, which most of us know as the 2008 financial services bailout bill.
Now, however, some big banks that got bailout help are facing their own tax issues in connection with foreclosed properties.
Ingham County, Mich., officials have field suit against Bank of America Corp., Wells Fargo & Co., as well as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corp. and two law firms that handle foreclosures, alleging that the institutions neglected to pay millions of dollars in transfer taxes on foreclosure sales.
The lawsuit contends that the defendants were part of an effort to "inappropriately" claim state and county tax exemptions on "improperly filed deeds." Many banks reportedly have used Fannie Mae and Freddie Mac to claim an exemption to the taxes by identifying themselves as government entities. Ingham County disagrees.
"We didn't specify damages, but I believe it’s in the millions for the county and tens of millions for the state," Curtis Hertel, Jr., Ingham County register of deeds, told Bloomberg news. The real estate transaction transfer tax rate for Michigan counties is $1.10 for every $1,000 of value being transferred, said Hertel. "We intend to fight for it."
Homebuyers are familiar with those transfer tax notations on the settlement sheet you get at a home's closing. But the Internal Revenue Service says expressly in several of its publications that you cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home. The deductible Schedule A home-related taxes are the annual property taxes.
All is not lost, however, when it comes to those transfer taxes.
If you are the buyer and you pay them, include them in the cost basis of the property. That will help reduce your profit when you sell, thereby reducing any tax you might owe.
If, on the other side of the closing table, you are the seller and you pay the transfer taxes, they are expenses of the sale and reduce the amount realized on the sale, again cutting any possible capital gains tax you might owe.
And all of Michigan is interested in getting the taxes paid.
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