Mortgage debt forgiven not considered taxable income

No income taxes owed for principal residence mortgage debt relief from a loan modification, short sale.

It is income tax season and if you had mortgage debt forgiven in 2012, you should be aware that you do not have to declare this as income.

On December 20, 2007, President George W. Bush signed into law the Mortgage Forgiveness Debt Relief Act of 2007. The act was extended until the end of this year, and, among other things, relieves the taxpayer from including cancelled debt arising from the home foreclosure process as income.

To qualify, the home must be the taxpayer’s “principal residence,” or the non‐business location where the tax payer and his or her family reside. This act applies to principal residence debt that has been cancelled between Jan. 1, 2007 and Jan. 1, 2013. Only home mortgage debt or debt incurred to improve the home is protected under this legislation, according to the IRS. If a borrower took a cash‐out refinance to pay off credit cards or to purchase a car or take a vacation etc., that portion of the debt is not protected and the borrower will have to pay taxes against it.

The borrower should have received a form 1099‐C from the lender. Michigan State University Extension suggests taxpayers contact a tax attorney to discuss how the Mortgage Forgiveness Debt Relief Act of 2007 impacts their tax liability. The law is complex and has a number of conditions and exemptions and only a qualified tax attorney can provide adequate counsel regarding a homeowner’s options. The act does not take away the right of lenders to seek the deficiency for the debt resulting from a foreclosure or a short sale. Seek the advice of an attorney to discuss the implications of a debt incurred through foreclosure.

You may be interested in other exceptions to the cancellation of debt tax reported on IRS Form 1099‐C.  Cancellation of debt income reported on a 1099‐C is not always taxable. The following are five additional exceptions to the general rule that cancellation of debt income is taxable:

  1. Bankruptcy: Debt cancelled or forgiven through bankruptcy is not considered taxable income.
  2. Insolvency: If you are insolvent when the debt is cancelled or forgiven, some or all of the cancelled debt may not be taxable. Generally, a taxpayer is insolvent when his or her total debts exceed the fair market value of his or her total assets. It is often difficult to determine whether or not a taxpayer is insolvent. If you think this applies to your situation consult a professional before filing your income tax return.
  3. Farm debts: If you incurred the debt directly in operation of a farm, you secure income from farming, and you secured the loan from an institution or agency regularly engaged in lending, you may be eligible for an exception.
  4. Nonrecourse loans: Forgiveness or cancellation of a non‐recourse loan does not result in cancellation of debt income but may have other tax consequences.
  5. Student loans: If a taxpayer’s student loans are cancelled under an agreement with the government lender, then the taxpayer need not include such cancelled debt in his or her taxable income.

It is highly recommended that taxpayers consult a qualified tax professional to discuss these matters in further detail to determine the best course of action.

Credit debt forgiveness is considered taxable income, and was covered in another MSU Extension news article Credit card debt forgiveness may be taxable.

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