Tax Relief Acts of 2007 and 2008: Homeowner Benefits Guide

1. The Mortgage Forgiveness Debt Relief Act of 2007 andThe Housing and EconomicRecovery Act of 2008 Alan Yee Tax Partner KMH LLP Alan Yee Managing Director AATS LLC

2. The Mortgage Forgiveness Debt Relief Act of 2007 included the following three new tax breaks for homeowners: • Provides tax relief for cancellation of indebtedness income relating to a primary residence, • Extends the temporary deduction for mortgage insurance and • Extends the period that a widow or widower could sell a primary residence and still claim the full $500,000 gain exclusion.

3. The Housing and Economic Recovery Act of 2008 included these tax provisions: • Allows non-itemizers to deduct a portion of their property taxes • Creates a $7,500 refundable “credit” for first-time homebuyers

4. Tax Relief for Cancellation of Indebtedness Income Some of the critical fine print in this new relief provision: • The tax relief applies to the original purchase price, plus improvements, of the taxpayer's principal residence. It doesn't 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. Refinanced indebtedness qualifies to the extent it doesn't exceed the amount of indebtedness being refinanced. (Cash out from refinancing doesn't qualify for the exclusion.) • The indebtedness must be incurred with respect to the taxpayer's principal residence only. The exclusion rule doesn't apply to second homes, vacation homes, business property, or investment property, since these properties aren't the taxpayer's principal residence.

5. Tax Relief for Cancellation of Indebtedness Income (Cont.) • The relief provision is not a permanent fixture of the tax code. It only applies to forgiveness during 2007, 2008, or 2009. • Nontaxable forgiven mortgage debt is capped at $2 million ($1 million for married individuals filing separately). • When the relief provision applies, the basis of the individual's principal residence is reduced by the amount excluded from income. As a result of this basis reduction rule, the discharged indebtedness is, at least technically, subject to taxation at a later time, when the taxpayer sells or exchanges the principal residence. However, in many cases the reduction won't result in any additional tax, because any gain on that sale or exchange will qualify for the $250,000 ($500,000 for married couples filing jointly) home-sale exclusion.

6. Extends the Temporary Deduction for Mortgage Insurance • Mortgage insurance premiums will continue to be deductible after 2007, thanks to another relief provision for homeowners. • Originally, this deduction was available only for 2007. It now applies through 2010. • Basically, it allows taxpayers to treat amounts paid during the year for qualified mortgage insurance as home mortgage interest—and thus deductible in most instances. • The special rule for home mortgage interest is phased out at higher levels of adjusted gross income (AGI). • The insurance must be in connection with home acquisition debt, the insurance contract must have been issued after 2006. • The taxpayer must pay the premiums for coverage in effect during the year.

7. Extends the Period That a Widow or Widower Could Sell a Primary Residence Married taxpayers can exclude up to $500,000 of gain on the sale of their principal residence while single taxpayers are only allowed to exclude up to $250,000. For sales after 12/31/07, widows and widowers could take advantage of the full $500,000 exclusion only if the house was sold in the tax year of their spouse's death, without regard to when that death occurred. For example, if the death occurred on December 15, the surviving spouse had only until December 31 to make the sale. The new rules give the surviving spouse two years from the date of death to qualify for the full $500,000 exclusion.

8. Property Tax Deduction for Non-Itemizers • For 2008 only, taxpayers who do not itemize can still deduct a portion of their property taxes. The deduction is limited to the lesser of the taxes paid or $500 for single taxpayers and heads of households and $1,000 for married taxpayers filing a joint return.

9. Refundable Credit for First-Time Homebuyers • Eligible taxpayers are first-time homebuyers or those who have not owned a home used as a primary residence for at least three years. Owning a rental or vacation home does not count against the taxpayer for this test. There are income limits. • For qualified home purchases that close between April 9, 2008 and June 30, 2009, the purchaser can take a refundable credit equal to the lesser of $7,500 or 10 percent of the purchase price of the home. • Beginning in 2010, taxpayers will have to begin repaying the credit at a rate of $500 per year until the credit is fully repaid or up to 15 years for those who took the maximum credit.

10. Miscellaneous Tidbits • Under long-standing rules, taxpayers who file for bankruptcy under Title 11 or are insolvent both before and after the default or debt renegotiation will generally not be required to include the debt forgiveness in income. • For sales after 2008, gain potentially eligible for the homesale exclusion will be reduced proportionately for the period of time a home wasn't used as a principal residence. The prime example is a vacation home that is turned into a principal residence by its owners, but the new rule also can hit individuals who use a property as a main home for a while, rent it out for a period of time, and then move back in. There are, however, a number of exceptions.

11. More Miscellaneous Tidbits • In determining whether the sale of a residence converted to income-producing purposes resulted in a loss, and if so, the amount of the loss, any loss sustained by the taxpayer while he used the property as his residence must be excluded. The taxpayer cannot, merely by renting out his property for some time before the sale, secure for himself the deduction of a loss which would be disallowed if he had continued to use the property as his personal residence. • If a sale or exchange of the taxpayer's principal residence acquired in a tax-free like-kind exchange occurs more than five years after the date of the acquisition of the residence, gain exclusion applies. For sales and exchanges occurring after Dec. 31, 2008, a portion of a taxpayer's realized gain on a sale or exchange of a principal residence acquired in a like-kind exchange may be considered to be “gain allocated to periods of nonqualified use”.

12. State of Hawaii • The federal provisions have been adopted with respect to those noted below in the Mortgage Forgiveness Act.  See Act 93 of the Session Laws of 2008.  • Provides tax relief for cancellation of indebtedness income relating to a primary residence,:  Eff for debt discharged after 12/31/2006 and before 1/1/2010. • Extends the temporary deduction for mortgage insurance:  Effective for amounts paid or accrued after 12/31/2007 and before 1/1/2011. • Extends the period that a widow or widower could sell a primary residence and still claim the full $500,000 profit exclusion:  Effective for sales or exchanges after 12/31/2007. • Any changes contained in the Housing and Economic Recovery Act will not be considered until the 2009 Legislative session.