Notes from Charlotte County, Florida

House Bill #3648 PASSES - this bill just passed and makes a huge difference on the liabilities of a homeowner who has sold through a short sale. We have found the biggest fear of these homeowners is that they may have huge tax liabilities and be given a 1099 by the IRS at the end of the year. No longer the case!

In a tax-Peter-to-pay-Paul move, the House Ways and Means Committee voted to remove the so-called phantom income tax that haunts financially distressed homeowners whose debt is partially forgiven by a lender after a foreclosure or a "short sale" to avoid foreclosure.

Under the law, when a creditor forgives or cancels all or part of a debt, the amount forgiven is treated as taxable income. That is particularly harsh on homeowners who can't pay their mortgage, then lose their house in a "short sale" or foreclosure. If the sale proceeds aren't sufficient to retire their principal debt, and the lender agrees to cancel the missing balance, the IRS treats the forgiveness or cancellation of debt as taxable income.

Picture this scenario: To avoid foreclosure, you agree to sell your house to an investor for less than the amount you owe the lender. Say the shortfall is $20,000. If the lender cancels that balance as part of your negotiations, the IRS will demand income taxes on the $20,000 -- even though you've never actually pocketed that cash. It's phantom income, but the IRS requires your lender to file a Form 1099-C reporting that it canceled your debt. Think of it as the tax code's version of kicking you while you're down.

The Ways and Means Committee bill (H.R. 3648) will exclude home mortgages from the current tax code's "discharge of indebtedness" rules retroactive to Jan. 1 of 2007.