If you have a debt canceled or forgiven, that amount may be taxable as income.
The Mortgage Debt Relief Act of 2007 allows taxpayers to exclude this amount as income if the discharge of debt was on their principal residence. This included debt reduced through mortgage restructuring, short sale, or mortgage debt forgiven in connection with a foreclosure.
The provision applies to debt forgiven between 2007 and 2012, on amounts up to $2 Million ($1 Million if married filing separately).
Q: What is Cancellation of Debt?
A: If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances.
Q: Is Cancellation of Debt income always taxable?
A: No, there are some exceptions:
– Qualified principal residence indebtedness: This exception applies to most homeowners.
– Debts discharged through bankruptcy are not considered taxable income.
– If you are insolvent when the debt is cancelled, some or all the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
– If you incurred the debt directly in operation of a farm, more then half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
– A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. Forgiveness of a non-recourse loan resulting from a foreclosure doesn’t result in cancellation of debt income. However, it may result in other tax consequences.
Q: What is the Mortgage Forgiveness Debt Relief Act of 2007?
A: The Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence.
Q: Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
A: No. The act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principle residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home.
Q: Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to refinance a home?
A: Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing would have qualified.
Q: How long is this special relief in effect for?
A: It is in effect for calendar years 2007 through 2012
Q: If the forgiven debt is excluded from income, do I have to report it on my tax return?
A: Yes. The amount of debt forgiven must be reported on Form 982. This form must be attached to your tax return.
Q: How do I know or find out how much debt was forgiven?
A: Your lender should send you a Form 1099-C.
Q: If part of the forgiven debt doesn’t qualify for the exclusion, may I qualify for exclusion under a different provision?
A: Yes. The forgiven debt may qualify under the insolvency exclusion. Normally, you are not required to include forgiven debts in income to the extent that you are insolvent. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy or if the debt is qualified farm indebtedness or qualified real property business indebtedness.
Q: Can I exclude cancellation of credit card debt?
A: In some cases, yes. Nonbusiness credit card debt cancellation can be excluded from income if the cancellation occurred in a title 11 bankruptcy case, or to the extent you were insolvent just before the cancellation.
Q: How should I report the information and items needed to prove insolvency?
A: Use Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness to exclude canceled debt from income to the extent you were insolvent immediately before the cancellation.