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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 lender’s
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?
There is no dollar limit if the
principal balance of the loan was less than
$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. |
