The Mortgage Forgiveness Debt Relief Act of 2007 was due to expire December 31, 2012 but has been extended to 12-30-2013. The Mortgage Forgiveness Debt Relief Act eliminates any income tax that happens from unpaid debt or debt forgiveness for a mortgage on you primary home. Income tax can be assessed by the IRS from a short sale or mortgage modification. Without a Bankruptcy or the Mortgage forgiveness act, any deficiency or unpaid debt will be treated as ordinary income and taxed accordingly.
Example: If a property sells in a short sale, deed in lieu, foreclosure or there is a mortgage modification and the mortgage company loses 100,000 the mortgagor reports income for 100,000 on a 1099C.
Debt Relief Act Rules
Mortgage modifications and shorts sales are difficult processes and homeowners are already struggling. In November, 2012, forty-one state attorney generals appealed to Congress asking that the Mortgage Forgiveness Debt Act be extended. However it appears that it will shortly expire. But here are some of the rules of the act.
- To qualify, you have to use 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. Bankruptcy filed prior to charging off the debt or forgiveness always qualifies for exclusion from income.
- Under the Mortgage Forgiveness Debt Relief Act of 2007, you may exclude up to $1 million per person of debt forgiveness or 2 million for a couple but it must be for your principal residence. But special rules apply.
- The debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
- Refinanced debt for substantially improving a principal residence qualifies.
- Any other purpose like buying a car does not qualify for the exclusion.
- Vacation or second homes, rental property, business property, do not qualify for the tax relief provision of the Mortgage Forgiveness Debt Relief Act or 2007.
- If any debt is reduced or eliminated you will receive Form 1099-C, Cancellation of Debt, from the lender. Refer to form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness.