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Ten Facts about Mortgage Debt Forgiveness
Unfortunately in the bad economic times some of my clients have had
to get out of their mortgages either through foreclosure or short
sales or have modified their loans. Many are shocked to find that
there may be unintended tax consequences in doing so. If your
mortgage debt is partly or entirely forgiven during tax years 2007
through 2012, you may be able to claim special tax relief and
exclude the debt forgiven from your income. Here are 10 facts you
should know about Mortgage Debt Forgiveness.
1.
Normally, debt
forgiveness results in taxable income. However, under the Mortgage
Forgiveness Debt Relief Act of 2007, you may be able to exclude up
to $2 million of debt forgiven on your principal residence.
2.
The limit is $1 million for a married person filing a separate
return.
3.
You may exclude debt reduced through mortgage restructuring, as well
as mortgage debt forgiven in a foreclosure.
4.
To qualify, the debt must have been used to buy, build or
substantially improve your principal residence and be secured by
that residence.
5.
Refinanced debt proceeds used for the purpose of substantially
improving your principal residence also qualify for the exclusion.
6.
Proceeds of refinanced debt used for other purposes – for example,
to pay off credit card debt – do not qualify for the exclusion.
7.
If you qualify, claim the special exclusion by filling out Form 982,
Reduction of Tax Attributes Due to Discharge of Indebtedness, and
attach it to your federal income tax return for the tax year in
which the qualified debt was forgiven.
8.
Debt forgiven on second homes, rental property, business property,
credit cards or car loans does not qualify for the tax relief
provision. In some cases, however, other tax relief provisions –
such as insolvency – may be applicable. IRS Form 982 provides more
details about these provisions.
9.
If your debt is reduced or eliminated you normally will receive a
year-end statement, Form 1099-C, Cancellation of Debt, from your
lender. By law, this form must show the amount of debt forgiven and
the fair market value of any property foreclosed.
10.
Examine the Form 1099-C carefully. Notify the
lender immediately if any of the information shown is incorrect. You
should pay particular attention to the amount of debt forgiven in
Box 2 as well as the value listed for your home in Box 7.
Hopefully this is never
something you will have to deal with but if you find yourself in
trouble please call our office as soon as possible so we can walk
through all of these issues as well as the myriad alternatives to
foreclosure.
Michael T. McCormick, JD, LL.M.
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