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The Mortgage Forgiveness Debt Relief Act and Debt Cancellation
If
you owe a debt to someone else and they cancel or forgive that debt, the
canceled amount may be taxable.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude
income from the discharge of debt on their principal residence. Debt reduced
through mortgage restructuring, as well as mortgage debt forgiven in connection
with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up
to $2 million of forgiven debt is eligible for this exclusion ($1 million if
married filing separately). The exclusion does not apply if the discharge is due
to services performed for the lender or any other reason not directly related to
a decline in the home's value or the taxpayer's financial condition.
More information, including detailed examples can be found in Publication
4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. Also see
IRS news release IR-2008-17.
The following are the most commonly asked questions and answers about The
Mortgage Forgiveness Debt Relief Act and debt cancellation:
What is Cancellation of Debt?
If you borrow money from a commercial lender and the lender later
cancels or forgives the debt, you may have to include the cancelled amount in
income for tax purposes, depending on the circumstances. When you borrowed the
money you were not required to include the loan proceeds in income because you
had an obligation to repay the lender. When that obligation is subsequently
forgiven, the amount you received as loan proceeds is normally reportable as
income because you no longer have an obligation to repay the lender. The lender
is usually required to report the amount of the canceled debt to you and the IRS
on a Form 1099-C, Cancellation of Debt.
Here's a very simplified example. 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 generally is taxable
income to you.
Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when
cancellation of debt income is not taxable involve:
- Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
- Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
- Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
- Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
- Non-recourse loans: A non-recourse loan is a loan for which the lenders only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
These
exceptions are discussed in detail in Publication 4681.
What is the Mortgage Forgiveness Debt Relief Act of 2007?
The Mortgage Forgiveness Debt Relief Act of 2007 was enacted on December 20,
2007 (see News Release IR-2008-17). Generally, the Act allows exclusion of
income realized as a result of modification of the terms of the mortgage, or
foreclosure on your principal residence.
What does exclusion of income mean?
Normally, debt that is forgiven or cancelled by a lender must be
included as income on your tax return and is taxable. But the Mortgage
Forgiveness Debt Relief Act allows you to exclude certain cancelled debt on your
principal residence from income. Debt reduced through mortgage restructuring, as
well as mortgage debt forgiven in connection with a foreclosure, qualifies for
the relief.
Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or
cancelled debts?
No. The Act applies only to forgiven or cancelled debt used to buy,
build or substantially improve your principal residence, or to refinance debt
incurred for those purposes. In addition, the debt must be secured by the home.
This is known as qualified principal residence indebtedness. The maximum amount
you can treat as qualified principal residence indebtedness is $2 million or $1
million if married filing
separately.
Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to
refinance a home?
Debt used to refinance your home qualifies for this exclusion, but only to the
extent that the principal balance of the old mortgage, immediately before the
refinancing, would have qualified. For more information, including an example,
see Publication 4681.
How long is this special relief in effect?
It applies to qualified principal residence indebtedness forgiven in
calendar years 2007 through 2012.
Is there a limit on the amount of forgiven qualified principal residence
indebtedness that can be excluded from income?
The maximum amount you can treat as qualified principal residence
indebtedness is $2 million ($1 million if married filing separately for the tax
year), at the time the loan was forgiven. If the balance was greater, see the
instructions to Form 982 and the detailed example in Publication 4681.
If the forgiven debt is excluded from income, do I have to report it on
my tax return?
Yes. The amount of debt forgiven must be reported on Form
982 and this form must be
attached to your tax return.
Do I have to complete the entire Form 982?
No. Form 982, Reduction of Tax Attributes Due to Discharge of
Indebtedness (and Section 1082 Adjustment), is used for other purposes in
addition to reporting the exclusion of forgiveness of qualified principal
residence indebtedness. If you are using the form only to report the exclusion
of forgiveness of qualified principal residence indebtedness as the result of
foreclosure on your principal residence, you only need to complete lines 1e and
2. If you kept ownership of your home and modification of the terms of your
mortgage resulted in the forgiveness of qualified principal residence
indebtedness, complete lines 1e, 2, and 10b. Attach the Form 982 to your tax
return.
Where can I get this form?
If you use a computer to fill out your return, check your
tax-preparation software. You can also download the form at IRS.gov, or call
1-800-829-3676. If you call to order, please allow 7-10 days for delivery.
How do I know or find out how much debt was forgiven?
Your lender should send a Form 1099-C, Cancellation of Debt, by
February 2, 2009. The amount of debt forgiven or cancelled will be shown in box
2. If this debt is all qualified principal residence indebtedness, the amount
shown in box 2 will generally be the amount that you enter on lines 2 and 10b,
if applicable, on Form 982.
Can I exclude debt forgiven on my second home, credit card or car loans?
Not under this provision. Only cancelled debt used to buy, build or
improve your principal residence or refinance debt incurred for those purposes
qualifies for this exclusion. See Publication 4681 for further details.
If part of the forgiven debt doesn't qualify for exclusion from income
under this provision, is it possible that it may qualify for exclusion under a
different provision?
Yes. The forgiven debt may qualify under the insolvency exclusion.
Normally, you are not required to include forgiven debts in income to the extent
that you are insolvent. You are insolvent when your total liabilities
exceed your total assets. The forgiven debt may also qualify for exclusion if
the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is
qualified farm indebtedness or qualified real property business indebtedness. If
you believe you qualify for any of these exceptions, see the instructions for
Form 982. Publication 4681 discusses each of these exceptions and includes
examples.
I lost money on the foreclosure of my home. Can I claim a loss on
my tax return?
No. Losses from the sale or foreclosure of personal property are
not deductible.
If I sold my home at a loss and the remaining loan is forgiven, does
this constitute a cancellation of debt?
Yes. To the extent that a loan from a lender is not fully satisfied and
a lender cancels the unsatisfied debt, you have cancellation of indebtedness
income. If the amount forgiven or canceled is $600 or more, the lender must
generally issue Form 1099-C, Cancellation of Debt, showing the amount of debt
canceled. However, you may be able to exclude part or all of this income if
the debt was qualified principal residence indebtedness, you were insolvent
immediately before the discharge, or if the debt was canceled in a title 11
bankruptcy case. An exclusion is also available for the cancellation of
certain non-business debts of a qualified individual as a result of a disaster
in a Midwestern disaster area. See Form 982 for details.
If the remaining balance owed on my mortgage loan that I was personally liable
for was canceled after my foreclosure, may I still exclude the canceled debt
from income under the qualified principal residence exclusion, even though I no
longer own my residence?
Yes, as long as the canceled debt was qualified principal residence
indebtedness. See Example 2 on page 13 of Publication 4681, Canceled Debts,
Foreclosures, Repossessions, and Abandonments.
Will I receive notification of cancellation of debt from my lender?
Yes. Lenders are required to send Form 1099-C, Cancellation of Debt,
when they cancel any debt of $600 or more. The amount cancelled will be in box 2
of the form.
What if I disagree with the amount in box 2?
Contact your lender to work out any discrepancies and have the lender
issue a corrected Form 1099-C.
How do I report the forgiveness of debt that is excluded from gross
income?
(1) Check the appropriate box under line 1 on Form 982, Reduction of
Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis
Adjustment) to indicate the type of discharge of indebtedness and enter the
amount of the discharged debt excluded from gross income on line 2. Any
remaining canceled debt must be included as income on your tax return.
(2) File Form 982 with your tax return.
My student loan was cancelled; will this result in taxable income?
In some cases, yes. Your student loan cancellation will not result in
taxable income if you agreed to a loan provision requiring you to work in a
certain profession for a specified period of time, and you fulfilled this
obligation.
Are there other conditions I should know about to exclude the
cancellation of student debt?
Yes, your student loan must have been made by:
(a)
the federal government, or a state or local government or subdivision;
(b) a tax-exempt public benefit corporation which has control of a state, county
or municipal hospital where the employees are considered public employees; or
(c) a school which has a program to encourage students to work in underserved
occupations or areas, and has an agreement with one of the above to fund the
program, under the direction of a governmental unit or a charitable or
educational organization.
Can
I exclude cancellation of credit card debt?
In some cases, yes. Non-business credit card debt cancellation can be
excluded from income if the cancellation occurred in a title 11 bankruptcy case,
or to the extent you were insolvent just before the cancellation. See the
examples in Publication 4681.
How do I know if I was insolvent?
You are insolvent when your total debts exceed the total fair market
value of all of your assets. Assets include everything you own, e.g., your
car, house, condominium, furniture, life insurance policies, stocks, other
investments, or your pension and other retirement accounts.
How should I report the information and items needed to prove
insolvency?
Use Form 982, Reduction of Tax Attributes Due to Discharge of
Indebtedness (and Section 1082 Basis Adjustment) to exclude canceled debt from
income to the extent you were insolvent immediately before the cancellation.
You were insolvent to the extent that your liabilities exceeded the fair market
value of your assets immediately before the cancellation.
To claim this exclusion, you must attach Form 982 to your federal income tax
return. Check box 1b on Form 982, and, on line 2, include the smaller of
the amount of the debt canceled or the amount by which you were insolvent
immediately prior to the cancellation. You must also reduce your tax
attributes in Part II of Form 982.
My car was repossessed and I received a 1099-C; can I exclude this
amount on my tax return?
Only if the cancellation happened in a title 11 bankruptcy case, or to
the extent you were insolvent just before the cancellation. See Publication 4681
for examples.
Are there any publications I can read for more information?
Yes.
(1) Publication 4681, Canceled
Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) is new
and addresses in a single document the tax consequences of cancellation of debt
issues.
(2) See the IRS news release IR-2008-17 with
additional questions and answers on IRS.gov.
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