Tax Debt Help - Tax Relief for Cancelled Debt & Mortgage Relief

People who have lost their homes through foreclosure or who have restructured their mortgage loans may qualify for tax relief under a new tax law, the Mortgage Forgiveness Debt Relief Act of 2007.

Highlights of Mortgage Debt Relief

Exclude up to $2 million of debt forgiven or canceled by a mortgage lender on a main home.
Both mortgage restrucuring and foreclosures qualify

Available for the years 2007, 2008, or 2009.

Claim the tax relief using IRS Form 982 (PDF)

What is Canceled Debt Income?Anytime a lender cancels, or forgives, your debt, that is considered income to the debtor. The tax laws considers this income, and the debtor is taxed on forgiven debt unless an exception applies.

Canceled Debt That is TaxableAnytime a lender cancels or forgives debt, that is usually a taxable event. "Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income." (Source: Publication 525)

Debt forgiveness is reported by the lender using Form 1099-C, Cancellation of Debt. Individuals report the forgiven debt on their Form 1040, Line 21 as other income.

The tax laws provide several exceptions to the tax treatment of forgiven debts. Tax-free treatment of mortgage debt is the most generous and easiest to calculate.

Mortgage Restructuring and ForeclosuresIndividuals who lost their homes through foreclosure will not have to pay income tax on the amount of mortgage debt that was forgiven or canceled. Tax-free treatment is also available to people who restructured their mortgages loans for a lower balance.

The tax-free exclusion applies to canceled mortgage debt of up to $2 million (or $1 million is married and filing a separate return). There are additional details to consider to qualify for this tax exclusion. The house must have been used as a main home, which means it was the principal place of residence for the debtor. Also, the debt must have been used to buy, build, or make substantial improvements to the residence.

Some mortgage debt won't qualify for this tax-free exclusion and will be considered taxable income. Mortgage loans that don't qualify include home equity loans where the proceeds were not used to buy, build, or improve the residence. Also, mortgages for second houses and rental properties do not qualify for the exclusion. However, some or all of this debt might qualify for other exclusions.

The IRS explains the tax break this way: "Taxpayers can exclude up to $2 million of debt forgiven on their principal residence. The limit is $1 million for a married person filing a separate return. This provision applies to debt forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure qualify for this relief." (Source: IRS.gov)

Individuals who qualify for this tax relief will need to use Form 982 to report the canceled debt.
Other Exclusions for Canceled DebtsBesides the provision for mortgages on main homes, the tax code provides other ways that canceled debt can be tax-free. Canceled debts do not need to be included in taxable income if the debt was canceled in a bankruptcy case, if the individual is insolvent, or if the canceled debt was intended as a gift. Certain business or farm property may also qualify for tax-free treatment.

The insolvency exclusion is particularly relevant, as it will likely apply to borrowers with home equity loans or mortgages on second homes and rental properties.

This insolvency provision will prove helpful to individuals who don't otherwise qualify for the mortgage debt relief. To be considered insolvent, the person's liabilities must exceed the fair market value of their assets. This is will be especially true of borrowers who's properties have dropped in value and who now must restructure their loans or surrender their properties through foreclosure.

You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. Determine your liabilities and the fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent. (Source: Publication 908)

Tax Debt Help - Form 982 to the Rescue

Mortgage Workouts, Now Tax-Free for Many Homeowners; Claim Relief on Newly-Revised IRS Form

IR-2008-17, Feb. 12, 2008 WASHINGTON — Homeowners whose mortgage debt was partly or entirely forgiven during 2007 may be able to claim special tax relief by filling out newly-revised Form 982 and attaching it to their 2007 federal income tax return, according to the Internal Revenue Service.Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec. 20, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return. Details are on Form 982 and its instructions, available now on IRS.gov. “The new law contains important provisions for struggling homeowners,” said Acting IRS Commissioner Linda Stiff. “We urge people with mortgage problems to take full advantage of the valuable tax relief available.” The late-December enactment means that reporting procedures for this law change were not incorporated into tax-preparation software or IRS forms. For that reason, people using tax software should check with their provider for updates that include the revised Form 982. Similarly, the IRS is now updating its systems and expects to begin accepting electronically-filed returns that include Form 982 by March 3. The paper Form 982 is now being accepted, but the IRS reminds affected taxpayers to consider filing electronically, which greatly reduces errors and speeds refunds. The new law applies to debt forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for this relief. In most cases, eligible homeowners only need to fill out a few lines on Form 982 (specifically, lines 1e, 2 and 10b). The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. See Form 982 for details. Borrowers whose debt is reduced or eliminated receive a year-end statement (Form 1099-C) from their lender. For debt cancelled in 2007, the lender was required to provide this form to the borrower by Jan. 31, 2008. By law, this form must show the amount of debt forgiven and the fair market value of any property given up through foreclosure. The IRS urges borrowers to check the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. Borrowers should pay particular attention to the amount of debt forgiven (Box 2) and the value listed for their home ( Box 7). Related Items: Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness 1099-C