Mortgage Forgiveness Debt Relief Act

Normally, if you borrow money from someone else, and that debt is later canceled or forgiven, the amount of money that is canceled or forgiven may be taxable as income by the IRS.

For instance, if you borrowed $50,000, and later repaid $40,000 but the remaining $10,000 was canceled or forgiven, that $10,000 could constitute income, for which you would owe income tax on. Most lenders would issue you IRS Form 1099-C (Cancellation of Debt), and you would be required to report that money on your tax return.

Given that home values have dropped considerably and some homeowners are turning to short sales, loan modifications, deed in lieu of foreclosure, and other options that reduce or forgive part of the principal amount of a home loan, this may have serious consequences at tax time.

If your mortgage is $200,000, and you obtain approval from your mortgage company to short sell your home for $120,000 to a new buyer, the difference between the mortgage ($200,000) and the short sale price ($120,000) is $80,000. After the short sale, the mortgage company will probably issue you IRS Form 1099-C listing the amount of $80,000 as being forgiven in the short sale. In theory you could have to pay income taxes on this $80,000!

But there are exceptions! In 2007 Congress passed, and President Bush signed into law, the Mortgage Forgiveness Debt Relief Act of 2007. It generally allows homeowners to EXCLUDE from their income the amount of money forgiven or canceled on their principal residence their home! This forgiveness provision applies between 2007 through 2012, and allows up to $2,000,000 to be forgiven.

Other exceptions include debts discharged through bankruptcy debts discharged in bankruptcy are not considered to be taxable income. And if you are insolvent (e.g. broke) when the debt is canceled, some or all of that canceled debt may not be taxable.

Debt used to refinance a home qualified for the Mortgage Forgiveness Debt Relief Act, but only up to the amount of the principal balance of the old mortgage before refinancing. For instance, if you took out a mortgage for $100,000 to buy the home and had repaid $20,000, you would owe $80,000 on your mortgage. If you later refinanced and your mortgage was now $130,000, only the first $80,000 (the amount of the old mortgage prior to refinancing) is tax exempt. You would likely owe taxes on any debt forgiven over $80,000.

Any debt that is forgiven, which is exempt from income tax, must still be reported on your income tax return! Use IRS Form 982 to report this forgiven debt, and attach it to your tax return. More information, including a copy of Form 982, can be found at the IRS website, http://www.irs.gov/individuals/article/0,,id=179414,00.html or by calling the IRS directly at 1-800-829-3676. Also see the IRS Publication and Form 982 here.

These are important but confusing regulations and provisions. You should consult a tax professional for any questions concerning this, or call the experienced attorneys at the Byrne Law Group by calling 813-413-6565 if you have any questions.