By Alvin Maglan, CPA
When you owe a debt to someone else and the debt is cancelled or forgiven, the canceled amount may be taxable. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to include income from the discharge of debt on their principal residence. Also, debt reduced through mortgage restructuring as well as debt forgiven in connection with foreclosure qualifies for the relief. The provision applies to debt forgiven in calendar years 2007 through 2014. Amounts up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).
Question: What is the duration of this special relief?
Answer: It applies to qualified principal residence indebtedness forgiven in calendar years 2007 through 2014.
Question: If the debt forgiven is excluded from income, should this be reported on the tax return?
Answer: Yes. The amount of debt forgiven must be reported on Form 982 and the form should be attached to the tax return.
CANCELLATION OF DEBT
When you borrow money and the lender later cancels or forgives your debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. If that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reported as income because you are no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you on a Form 1099-C, Cancellation of Debt.
Question: Is Cancellation of Debt income always taxable?
Answer: Not always. There are some exceptions, such as:
-Qualified principal residence indebtedness, the exception created by the Act and applies to most homeowners.
-Bankruptcy. Debts discharged through bankruptcy are not considered taxable income.
-Insolvency. If you are insolvent when debt is cancelled, some or all of the canceled 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.
-Non-recourse loans. A non-recourse loan is one for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. In such case, the lender cannot pursue you in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in a cancellation of debt income which may result in other tax consequences.
Question: Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
Answer: No. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debts incurred for those purposes. In addition, the debt must be secured by the home. This is called qualified principal home indebtedness and the maximum you can treat as a qualified principal residence indebtedness is $2 million or $1 million if married filing separately.
Question: Can I exclude debt forgiven on my second home, credit card or car loans?
Answer: Not under this provision. Only cancelled deb used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for exclusion.
Question: I lost money on the foreclosure of my home. Can I claim a loss on my tax return?
Answer: No. Losses from the sale or foreclosure of residential property are not deductible.
Alvin Maglan, CPA has more than 30 years of experience in tax matters having worked with accounting firm of SyCip, Gorres, Velayo & Co. and other Fortune 500 companies in the U.S. He works at Taxsaverspro, Inc. a tax consulting company that has a complete staff of Attorney, CPA and tax consultant that can help you save more on your taxes and in all problems in taxes. For free consultation you may call 1-877-456-9266.