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Foreclosure Tax Relief and the Mortgage Debt Relief Act

The Internal Revenue Service (IRS) generally considers forgiven debt to be taxable. That means you can incur a tax liability if your repayment obligation is canceled. In other words, if you owe someone money and they cancel or forgive that debt, you may owe taxes on the amount forgiven.

As many homeowners know all too well, it's easy to get overwhelmed by your mortgage payments. The housing market taking a turn for the worse could affect the value of your property. You might even find that you owe more on your house than its fair market value or sale price. Thankfully, several options are available to help you get back on your feet or transition to more affordable housing. But some of these options may have significant tax consequences, and it's important to be prepared for them. One way the federal government has tried to ease these tax consequences is through the Mortgage Forgiveness Debt Relief Act.

The Mortgage Debt Relief Act lets taxpayers exclude income from forgiven debt on their main residence. Property owners qualify for relief for:

The law originally applied to debt forgiveness between 2007 and 2012. Congress has repeatedly extended the law to allow borrowers continued relief on their income taxes. As of this writing, the Consolidated Appropriations Act (CAA) has extended the Mortgage Debt Relief Act to 2025.

Here are common questions about debt cancellation and the Mortgage Forgiveness Debt Relief Act.

What does 'cancellation of debt' mean?

Suppose you borrow some funds from a mortgage lender. Then, the lender forgives the full amount of the debt. Under ordinary circumstances, you'd probably have to report the canceled amount on your income taxes.

When you first borrow money, it's not considered income because you'll have to pay it back. But that debt obligation could be considered income when it's canceled or forgiven. This is because you no longer have to pay back the lender. The lender will report the canceled debt to you and the IRS on Form 1099-C, Cancellation of Debt.

For example, if you borrow $100,000 and fail to pay back $50,000 of it, you'll be in default. If the lender can't collect the other half, a cancellation of debt equal to $50,000 would be reported as taxable income.

When the housing bubble burst in 2006, many homeowners were left owing more on their home than it was actually worth. People witnessed the economy crumble in real time. Many people also struggled to make their mortgage payments since the whole economy was doing poorly and unemployment was high. Consequently, many homeowners worked with their lenders to have a portion of the debt forgiven. Or they were forced to sell their home in a foreclosure process or short sale.

Unfortunately, many people didn't realize that the federal government counts forgiven debt as income for tax assessment purposes. As a result, someone forced to sell their home in a foreclosure sale, with the remaining debt canceled, would have to include that canceled debt as income on their taxes the following year. For example, if you owed $400,000 on your home and sold it for $300,000 in a short sale approved by your lender, you would have to report $100,000 worth of income on your taxes.

What is the Mortgage Forgiveness Debt Relief Act of 2007?

The 2007 Congress passed the Mortgage Forgiveness Debt Relief Act. President Bush said at the time: “When your home is losing value and your family is under financial stress, the last thing you need is to be hit with higher taxes."

Under this law and subsequent legislation, taxpayers can exclude from income:

  1. Up to $750,000 if married for the tax year; or
  2. Up to $375,000 if married but filing separately

That means you can exclude the canceled debt from your income when you file your taxes with the IRS, whether:

But the exclusion for these canceled debts only applies to principal residences. So, second homes, rental homes, business property, credit cards, and car loans are not included in the Mortgage Forgiveness Debt Relief Act. Still, other tax relief provisions may apply to those. The debt also must have been used to buy, build, or substantially improve the principal residence. It must have also been secured by that residence. More information, including detailed examples, can be found on See Publication 4681 - Canceled Debts, Foreclosures, Repossessions, and Abandonments.

What is 'exclusion of income'?

You must usually report income on your tax return disclosures. The Mortgage Forgiveness Debt Relief Act creates an exclusion. It lets you exclude canceled debt from your income. The canceled debt must be in relation to the mortgage on your principal residence.

Does the Mortgage Forgiveness Debt Relief Act cover every canceled debt?

No. The canceled debt must be in relation to money borrowed to buy, construct, or improve your main residence. Also, the debt must be qualified principal residence indebtedness. This means it must be secured by your home.

Does the Mortgage Forgiveness Debt Relief Act cover refinance debts?

Yes, but only as far as the principal balance of the old mortgage would have qualified before you refinanced.

Is income-excluded forgiven debt still included on tax returns?

Yes. It is reported on Form 982, which is attached to your tax return.

Do I have to fill out all of Form 982?

No, as this form is used for other purposes as well. You may report forgiveness of qualified principal residence indebtedness on lines 1e and 2. If you maintained homeownership and but obtained forgiveness after loan modification, complete lines 1e, 2, and 10b.

Make sure to consult with an accountant or tax attorney to verify that the above requirements apply to your unique situation.

How do I determine the amount of forgiven debt?

Your lender will send a Form 1099-C before the tax year deadline. The form will describe the cancellation of debt. If this debt is all qualified principal residence indebtedness, the form's box 2 will be what you report on Form 982.

What about debt forgiven on a second home, vehicle loan, or credit card?

These kinds of debts aren't covered by the Mortgage Debt Relief Act.

If I face financial hardship not covered by the law, do I still have to pay tax on debt canceled in foreclosure?

The forgiven debt may be covered as an insolvency exclusion. You may be insolvent if your liabilities (debts) exceed your assets. Forgiven or canceled debt may also be excluded if it was:

The instructions in Form 982 and Publication 4681 have more information about qualification.

Can I claim a tax return loss for personal property lost in foreclosure?

No. Unfortunately, personal property losses aren't deductible under the Mortgage Forgiveness Debt Relief Act. But you should consult with an accountant for other potential tax credits or exemptions that may be available.

If my home is sold at a loss and the balance of the loan is canceled, does this count as a cancellation of debt?

Yes. The debt can be excluded from income if:

  • It was qualified principal residence indebtedness;
  • You were already insolvent right before the debt was forgiven; or
  • The debt was discharged in a Chapter 11 bankruptcy

Certain exclusions for disasters are also available. Form 982 contains more details.

If my mortgage balance was canceled after foreclosure, can I still exclude forgiven debt even though I no longer own the home?

Yes, as long as the canceled debt was qualified principal residence indebtedness. See Publication 4681.

Will I receive notification of cancellation of debt from my lender?

Yes. Lenders must issue Form 1099-C, Cancellation of Debt for $600 or more of canceled debt.

What if I disagree with the amount of canceled debt reported by my lender?

Get in touch with your lender and ask them to file and send you a corrected Form 1099-C.

Consider All Your Mortgage and Foreclosure Options

Many people are still feeling the effects of the housing crisis. If you've had to restructure your mortgage out of financial hardship, or you've lost your home entirely, the last thing you'd expect is a huge tax bill based on your forgiven debt “income." But without the Mortgage Forgiveness Debt Relief Act, you may be paying taxes on tens or hundreds of thousands of dollars.

Don't wait until tax preparation time to deal with these problems. It might also not be enough to consult only with a tax professional alone. Make an informed decision about your mortgage options by contacting an attorney experienced in foreclosures and foreclosure alternatives.

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