If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
In US law, when a lender decides to forgive all or a portion of a borrower’s debt and accept less, the forgiven amount is considered income for the borrower and is liable to be taxed.
Have you done a workout on your home loan? Have you had any of your mortgage forgiven? If so, law states you would be taxed on the amount of the forgiveness. Debt that is forgiven or canceled by a lender must be included as income on your tax return and is taxable.
However, the Mortgage Debt Relief Act of 2007 allows some debt to be forgiven. If your mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, mortgage restructuring, even mortgage debt forgiven due to foreclosure, may be forgiven from your income. Up to $2 million dollars of debt, $1 million if married filing separately, may be excluded on your principal residence.
The forgiveness applies only if directly related to a decline in the home’s value or the taxpayer’s financial condition. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion. The Act applies only to forgiven or canceled 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 owner occupied home. This is known as qualified principal residence indebtedness. Losses from the sale or foreclosure of personal property are not deductible.
If the amount forgiven or canceled is $600 or more, the amount of debt forgiven must be reported on Form 982 and attached to your tax return.
How do you know how much debt was forgiven? Your lender should send a Form 1099-C, Cancellation of Debt. This form must show the amount of debt forgiven and the fair market value of any property foreclosed. The amount of debt forgiven or canceled will be shown in box 2. If you disagree with the amount shown, contact your lender.
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. You are insolvent when your total debts exceed the total fair market value of all of your assets.
Talk to your lender and tax preparer to find out more.
Have any of you had experience with this?