Do You Know About the Mortgage Forgiveness Debt Relief Act?

If you are responsible for a debt that is ultimately forgiven by the creditor, the amount that was canceled out may be taxable. The 2007  Mortgage Forgiveness Debt Relief Act, enacted in December of 2007,  allows taxpayers to exclude income from a discharged debt in their principle residence. It allows that any debt reduced through mortgage restructuring or debt forgiven in instance of foreclosure, can qualify for such relief.

A cancellation of a debt is what occurs when you borrow money from a lender and then at a later point, the lender forgives, or cancels, the debt you owe. When you initially borrowed the money, any additional cash that went into your pocket did not have to be reported to the government because the full amount was expected to be paid back. When the obligation is erased, the amount discharged is then considered income.

Between the years of 2007 and 2012, the Mortgage Forgiveness Debt Relief Act will apply with up to $2 million dollars of forgiven debt allowed ($1 million if married and filing separately). Not all canceled debts will be taxable. There are exceptions, including:

Qualified principal residence indebtness for homeowners

Bankruptcy – Debts that have discharged through bankruptcy.

Insolvency – if you are insolvent (meaning your total debts are more than the fair market value of your total assets) when a debt is forgiven, some of the canceled debt may not be taxable, and in some cases, all of the canceled debt can be non-taxable.

Farm Debts – There are certain farm debts that will qualify as non-taxable. If you incurred debts directly from the operation of a farm, if more than half of your income from the previous three years was from farming, and the loan was owed to a personal who is considered a regular lender, your debts are typically not considered taxable.

Non-Recourse Loan – These are loans for which the lender’s only recourse in the case of default is to repossess the collateral, such as property. If the lender can not personally pursue you for the money, the forgive debt is not taxable.

If you have forgive debts that are excluded from your income, you must still report it on the Form 982 and attach it to your tax return to the IRS.