Canceled Mortgage Debt: What Happens at Tax Time?
Thanks to the Mortgage Forgiveness Debt Relief Act of 2007, homeowners who have had mortgage debt forgiven or canceled (perhaps through a mortgage modification or restructure) or who have suffered through a foreclosure may not owe income tax on that forgiven debt come tax time. To learn about the tax implications of forgiven debt and whether you can exclude forgiven mortgage debt from your taxable income on your tax return, read on. (If you’re interested in reading about foreclosure and mortgage modification, visit Nolo’s Foreclosure section. And, for more information on dealing with debt, check out Nolo’s Debt Collection Agencies topic .)
Canceled Debt Is Usually Taxed as Income
Ordinarily, when debt is forgiven or canceled by a lender, the amount that has been forgiven is considered income for tax purposes, whether the debt is a mortgage or another kind of credit. That means you must report the amount of the canceled (or forgiven) loan on your tax return and pay taxes on it, just like any other kind of income. The amount of the loan is considered income only once it’s forgiven — and not when you first borrowed the money. (When it’s clear you won’t be repaying the money you received, tax law recognizes the money as income.)
The Mortgage Forgiveness Debt Relief Act of 2007
To keep financially strapped homeowners from taking a second hit at tax time, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007. What this means for taxpayers is that, if part or all of your mortgage debt on your principal residence is forgiven in any tax year from 2007 to 2013, you might be able to exclude as much as $2 million of that forgiven debt from your taxable income.
The Act was originally scheduled to sunset in 2010, but was extended through 2012 by the Emergency Economic Stabilization Act of 2008. It was extended again (through 2013) by the fiscal cliff legislation in early 2013. And then extended one more time on December 19, 2014 in the Tax Increase Prevention Act — it now includes debt forgiven through 2014.
Can You Get Tax Relief for Your Forgiven Mortgage Debt?
If some or all of your mortgage debt has been forgiven or canceled by your lender, will you be able to get out of paying income tax on that forgiven debt under the Mortgage Forgiveness Debt Relief Act of 2007? Here are some key factors to consider.
- Only mortgage debt canceled or forgiven sometime in the calendar years (not tax years) 2007 to 2014 qualifies under the Act.
- The forgiven debt must have been incurred to purchase, build, or make significant renovations to your principal residence (not a vacation home or a property you rent out to others). The IRS jargon for this kind of debt is “qualified principal residence indebtedness.”
- Qualifying debt can include mortgages that were reduced through modification or restructuring or mortgage debt that has been canceled altogether through foreclosure.
- Proceeds from refinanced debt will qualify for exclusion from income only if those proceeds were used to make significant renovations or improvements to your principal residence — not to make purchases or pay other bills.
- If your forgiven mortgage debt qualifies, you can exclude up to $2 million of the amount of the debt ($1 million if you are married and filing separately).
- You can find out the exact amount of mortgage debt that’s been forgiven by looking at any paperwork sent by your lender. Specifically, look for a notice called “Form 1099-C: Cancellation of Debt.”
- If your forgiven debt qualifies under the Mortgage Forgiveness Debt Relief Act of 2007, even though the debt will be excluded from your income and you won’t need to pay income taxes on it, you still need to report the forgiven debt to the IRS (on Form 982) as part of your tax return.
The IRS has more information about the Mortgage Forgiveness Debt Relief Act of 2007 and instructions for taxpayers at www.irs.gov. And, for more tips on getting your tax return together this year, visit Nolo’s Personal Income Taxes section.