Mortgage Forgiveness Debt Relief Act

The Mortgage Forgiveness Debt Relief Act became law December 20, 2007.

This law states that you should not receive a 1099 form for the debt forgiven for a loan secured by a qualified principal residence. So, if a you sold your home for less than the mortgage amount and the lender forgave the remaining debt, you no longer have to list that amount as taxable income.

Normally in US law, when a lender decides to forgive all or a portion of a borrower’s debt and accept less, the forgiven amount is considered income for the borrower and may be taxed.

However, since the Mortgage Forgiveness Act, amendments have been made to remove such tax liability and allow the borrower and lender to work together to find a solution that is beneficial to both parties. This protection is limited to principal residences — rental properties are ineligible for relief — so ask you tax advisor to be sure you qualify.

Principal residence in this case is a property where you’ve lived for 2 out of the last 5 years. If you did not occupy the property as your residence, the amount forgiven is taxable.

Through the Act, you may exclude debt reduced through mortgage restructuring as well as mortgage debt forgiven in connection with a foreclosure.

Qualifying acquisition indebtedness is any indebtedness that
1. is incurred in purchasing, constructing, or improving any qualified residence of the taxpayer and,
2. is secured by the residence and,
3. is secured by the property resulting from the refinancing of any of the above indebtedness, but not to exceed the original indebtedness.

What does not qualify? If you refinanced your original home loan and used the money you received to go on a vacation or buy a car, the money you took out will be taxed.

The maximum amount that can be discharged and excluded from income is $2,000,000 for a married couple filing a joint return or $1,000,000 for a married person filing a separate return.

The effective date of the law is for discharges on or after January 1, 2007, and for indebtedness discharged before January 1, 2010.

Can you claim a loss on your tax return if you lost money on the foreclosure of your home?
No. Losses from the sale or foreclosure of personal property are not deductible.

If the forgiven debt is excluded from income, do you have to report it on your tax return?
Yes. The amount of debt forgiven must be reported on Form 982 and this form must be attached to your tax return.

Will you receive notification of cancellation of debt from your lender?
Yes. Lenders are required to send Form 1099-C, Cancellation of Debt, when they cancel any debt of $600 or more. The amount canceled will be in box 2 of the form.

Will this debt forgiveness be extended past January 1, 2010? There is much discussion against extension.

To read more about it, go to IRS.gov.

***UPDATE*** this bill was amended and extended through December 31, 2012.