J. William Seabrooke CPA P.C.

The exclusive purpose for the information which is provided from this website is to disseminate information, and not to provide tax advice.

 While there are several different scenarios in which this provision of the tax laws applies, one typical situation occurs when you (A) owe money to a lender (B) and are not able to repay that debt. You don’t meet the requirements for filing under the bankruptcy laws.  B acknowledges the fact that sooner or later you will default or abandon the property (if you have not already done so).  B “forgives” (writes off the unpaid balance or destroys the mortgage note) the unpaid balance of the debt that you owe him/her.  You may now have reportable and taxable income.  The essence of the transaction is that you received something of real value – a forgiven (as in debt elimination) note.  You now longer owe B a dime!!  At the end of the year B writes off the unpaid debt as a “Bad Debt Expense” and issues you a Form 1099 C (“Cancellation of Debt”)    Here is the link to the instructions for this form:  http://www.irs.gov/pub/irs-pdf/i1099ac.pdf   In certain circumstances you may also receive a 1099 A (“Acquisition or Abandonment of Secured Property”).  If you meet the requirements, you may qualify for a partial or total exclusion of the taxable income under the provisions of the “Mortgage Forgiveness Debt Relief Act of 2007” which applies to tax years 2007 – 2012. 

You may need to consult with the Internal Revenue Service, the issuer of the 1099 C, your tax preparer, or a tax attorney. 

Mortgage Debt Forgiveness: 10 Key Points

Canceled debt is normally taxable to you, but there are exceptions. One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1.   Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2.   The limit is $1 million for a married person filing a separate return.

3.   You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4.   To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5.   Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6.   Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7.   If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8.   Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9.   If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10.   Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant available on the IRS website to determine if your cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.

Finally, you may obtain copies of IRS publications and forms either by downloading them from www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Form 982
• Form 1099-C
• Publication 4681

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