Mortgage Forgiveness Debt Relief Act

Throughout the mortgage crisis, the IRS has continued to reassure homeowners that, although mortgage workouts and foreclosures can have tax consequences, special tax relief provisions may reduce or eliminate the extra tax burden for financially strapped borrowers who lose their homes.

Taxpayers who find they owe additional tax can use a simple form to request an installment payment agreement with the IRS. In some cases, eligible taxpayers may qualify to settle their tax debt for less than the full amount due using an offer-in-compromise.

Home Foreclosures

You should consider your options carefully before giving up your home through foreclosure. Under current tax law, if the debt wiped out through foreclosure exceeds the value of the foreclosed property, the difference is normally taxable income. But a special rule allows insolvent borrowers to offset that income limited by the amount their liabilities exceed their assets.

But be careful; under the law, relief may be limited or unavailable in some situations where, for example, part or all of a home was used for business or rented out.

Cancelled or Reduced Debt

Borrowers whose debt is reduced or eliminated should receive a year-end statement (Form 1099-C) from their lender. By law, this form must show the amount of debt forgiven and the fair market value of property given up through foreclosure. Though the winning bid at a foreclosure auction is normally considered to be a property's fair market value, it may not necessarily reflect its true value.

If you have cancelled or reduced debt, you should check your Form 1099-C carefully and notify the lender immediately if any of the information shown on the form is incorrect. You should pay particular attention to the amount of debt forgiven (Box 2) and the value listed for your home (Box 7). You will need to report these values on your tax return.

Sample Form 1099-C, Cancellation of Debt

Taxable Income and the Mortgage Debt Relief Act

Cancelled debt from commercial mortgage lenders is often included as taxable income on your federal income taxes. The Mortgage Debt Relief Act of 2007, however, allows some taxpayers to exclude debt forgiven on their primary place of residence. Debt that qualifies for the relief includes debt reduced through mortgage restructuring as well as mortgage debt forgiven in connection with a foreclosure. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). This provision applies to debt forgiven in calendar years 2007 through 2012.

The taxpayer must have used the debt to buy, build, or substantially improve the taxpayer's primary residence. Debt used to refinance qualifying debt is also eligible for the exclusion up to the amount of what the old mortgage principal was prior to the refinancing. Debt forgiven on second homes, rental property, business property, credit cards, or car loans does not qualify for tax relief. In some cases other kinds of tax relief, based on insolvency (or inability to finance debt) may be available. Taxpayers will receive an official statement from their lender indicating the amount of debt forgiven. The taxpayer must then fill out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness which indicates the type and amount of debt forgiveness to be reduced from gross income, and submit it with their tax return. The proper form will be completed for you by the efile.com tax software during your online tax return preparation.

For more information, please see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments