Blog Post

There is good news this tax season for thousands of homeowners who have negotiated loan modifications, mortgage refinancing, or foreclosures this past year! As we all scramble to make sure that we are receiving the maximum rewards and deductions, there is one exemption that homeowners should not overlook. Enacted in 2007, The Mortgage Debt Relief Act allows tax payers to exclude income from forgiven debt on their primary residence as a result of loan modification or foreclosure. The Act will remain in effect until 2012 and is capped at $2 million in forgiven debt ($1 million for married couples filing separately).

Under normal circumstances, most debts that have been forgiven or cancelled by a lender must be considered taxable income. The lender is usually required to report the forgiven amount to the borrower as well as the IRS in the form of a 1099-C, Cancellation of Debt. The IRS has outlined this example to illustrate a cancellation of debt: “You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which is generally taxable income to you.” The purpose of the Act is to prevent homeowners from paying extra taxes due to delinquent mortgage or foreclosure.

It is important to know, however, that the Act does not apply to all cancellations of debt. The IRS has set out certain guidelines to determine whether or not you qualify for the Debt Relief Act. The Act may only be applied if the debt was incurred to build, buy, or improve your primary residence. The Act does not apply to second homes, vacation homes, investment condos, or other residences that are occupied for less than half of the year. It also cannot be used for refinanced mortgages used to pay off other debts such as car payments, tuition expenses, or credit card debt. Visit www.IRS.gov for more complete information on whether or not you qualify.

Posted 17th March 2011 by Sally Forster Jones