What is the Mortgage Forgiveness Debt Relief Act and Debt Cancellation?

What is the Mortgage Forgiveness Debt Relief Act and Debt Cancellation

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If you have had debt reduced through mortgage restructuring or debt forgiveness from your mortgage, law states that you would be taxed on the amount of the forgiveness.

When a lender decides to cancel or forgive all or a portion of a borrower's debt, the forgiven amount is considered income for the borrower; therefore, it is liable to be taxed. The amount forgiven must be included as income on your tax return.

However, the Mortgage Debt Relief Act of 2007 allows taxpayers to exclude income from the forgiveness of debt on their personal residence. Debt reduced through mortgage restructuring or mortgage debt forgiveness qualifies for the relief.

The relief applies to debt forgiven from 2007 through 2012. Up to $2 million of debt, $1 million if married filing separately, may be excluded. The exclusion will not apply if the forgiveness is due to services performed for the lender for reasons not directly related to a decline in the home's value or the financial condition of the taxpayer.

Now, the cancelation of debt income is not always taxable. Situations where the cancellation of debt income is not taxable include qualified principal residence indebtedness, which was created by the act and applies to most homeowners, debts discharged through bankruptcy, or if you are insolvent when the debt is cancelled- meaning your total debts are more than the market value of your assets.

Other situations include certain farm debts. If you incurred the debt in operation of the farm and more than half of your income from the prior three years was from the farm, and the loan was owed to an agency or person engaged in lending, the cancelled debt is usually not considered taxable income. Non-recourse loans, a loan that the lenders only remedy in case of default is to repossess the property being financed, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not cancel debt income, although it may result in other tax consequences.

The Mortgage Forgiveness Debt Relief Act does not apply to all forgiven or cancelled debts. It applies to forgiven or cancelled debts that are used to buy, build or improve your residence or to refinance debt incurred from those. Debt incurred to refinance a home qualifies to the extent of the balance of the old mortgage immediately before refinancing. Foreclosure of personal property or losses from the sale is not deductible.

Your lender will send Form 1099-C, Cancellation of Debt, which will show you how much debt was forgiven. The amount will be shown in Box 2. Forgiven debt excluded from income needs to be reported on Form 982 and attached to the tax return. You can get the form from tax-preparation software or download it at IRS.gov.

Scottsdale Law Group is dedicated to providing clients with the most efficient, cost effective professional consultation and management of personal financial and real estate matters. To learn more about Scottsdale Law Group and how they can help you, please visit www.scottsdalelawgroup.com.

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