If your home loan is foreclosed or you otherwise have debt that is cancelled, it is best if you notify the bank or home lender of your new address.  This way important tax information that has been sent to the IRS will also get to you and will not be subject to possible loss in the mail.

Even if you think your home was worth more than the amount you owed the lender at the time of the foreclosure sale, the lender may come to a different conclusion.  If your lender sends you a 1099-C that shows cancelled debt, this is the information that the IRS will receive.  If you fail to deal with it on your tax return, you may end up being assessed additional tax.

Related posts:

1. Tax Fact 7-IRS Form 982 is Important
2. Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits
3. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence

When debt is forgiven on a second home, rental property, business property or for debts such as credit cards or car loans, the Mortgage Forgiveness Debt Relief Act of 2007 does not apply.  The exclusion for insolvency, qualified business property, or even bankruptcy may apply.  However, timing is important.  The instructions for IRS Form 982 explain how to use these and other exceptions to the tax on cancelled debt.  However, a trip to a CPA, Enrolled Agent or other tax professional may be wise in these circumstances. 

Most taxpayers do not even know that debt cancellation can result in taxable income.  The tax code can be complicated and filled with exceptions to the rules it states.  If you have cancelled debt in the tax year, be careful with your tax return or you may get a letter from the IRS claiming you owe more tax than was calculated on the return.

Related posts:

1. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
2. Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits
3. Tax Fact 6-Cancelled Debt From a Refinance Can Be Taxable Income

If you have cancelled debt and do not file a Form 982 with your tax return, or do not otherwise report the income from mortgage debt forgiveness or other cancelled debt on your tax return, the IRS may write you a letter and propose the assessment of additional tax.  A failure to respond to such an IRS letter within 30 days will result in an issuance of a Statutory Notice of Deficiency, and the assessment of additional tax.  Look for my article on responding to IRS notices for what you need to do if the IRS tries to tell you, you owe more tax.

The business about tax attributes is serious.  While the Mortgage Forgiveness Debt Relief Act of 2007 does give a foreclosed homeowner the ability to exclude certain types of cancelled debt from income, there can be a price to pay.  For this reason, and many others, it may be appropriate to consult a tax professional if a foreclosure occurs in the year for which the return is being prepared.  Watch out for a  1099-A and/or 1099-C from the lender indicating that debt was cancelled.

Related posts:

1. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence
2. Ten Tax Facts About Mortgage Forgiveness
3. Tax Fact 9-Make Sure Address Current With Mortgage Lender

Also it should be noted that funds from a refinance used to pay college tuition do not qualify for the exclusion. Many parents borrowed against their homes to fund college education for their children.  Despite the noble intent, Congress did not see fit to exclude debt incurred for this purpose from inclusion as taxable income if the debt is cancelled.  This does not mean you have to pay tax if you borrowed money against your home to pay for a college education.  However, if your home is foreclosed and the value of your home at the time of foreclosure is less than the amount of the debt, and a portion of that debt was used for a purpose other than buying, building or substantially improving your home, the amount cancelled may be taxed as income.

This series of articles focus on the Mortgage Forgiveness Debt Relief Act of 2007 and how it may avoid a tax liability.  In addition to this statutory exclusion from income for tax purposes, there are other exclusions that could apply.  For example, bankruptcy discharge or insolvency at the time the debt was cancelled could exclude some or all of the debt that has been cancelled from income for tax purposes.

Related posts:

1. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
2. Tax Fact 5-Refinance Debt for Improvements is Excludable
3. Tax Fact 3-Debt Cancelled through Mortgage Restructuring is Eligible

If a foreclosure occurs or mortgage debt is forgiven in some other way, it is important to pay attention to what type of debt was involved.  If the money was used to buy, build, or substantially improve the principle residence of the taxpayer, it qualifies for exclusion of the Mortgage Forgiveness Debt Relief Act of 2007.  If the debt and the money was used to pay off the original loan it is also subject to exclusion from income if it is cancelled.  Finally, even if new money comes out of a refinance loan, as long as that money is used to make a substantial improvement in the home, it becomes “qualified principle residence debt” and is excludable from income.  This statutory exclusion from income is scheduled to expire December 31, 2012.

Related posts:

1. Tax Fact 6-Cancelled Debt From a Refinance Can Be Taxable Income
2. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
3. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence

With the substantial increase in home prices that occurred over the ten years beginning in 2000, many people sought to access this “residential piggy bank” by refinancing their home.  Often, the funds borrowed in such a refinance were used to pay bills unrelated to the principal residence like credit card debt.  The IRS will not allow the use of that “residential piggy bank” money for general consumer expenditures.  If the money is not spent on the principal residence, the taxpayer will not be permitted to exclude it from income if the debt gets cancelled.  If the money is used for some purpose other than buying, making a substantial improvement or building your home it is not “qualified” for the exclusion allowed by the Mortgage Forgiveness Debt Relief Act of 2007.

It is important to note that borrowing against a home does not create a tax liability in and of itself.  A taxpayer can borrow against a principal residence and use that money for any purpose.  However, if the debt is cancelled, that portion of the debt secured against the home and used for purposes other than paying off existing debt that is “qualified” would constitute taxable income unless it is otherwise excluded.

In most cases, if a home equity line of credit is cancelled in whole or in part, by foreclosure, short sale or restructuring, the amount cancelled or forgiven will be considered income in the year in which the cancellation occurred.  The Mortgage Forgiveness Debt Relief Act of 2007 will not exclude any portion of the home equity line of credit unless it too was used for substantial improvement of the home.  However, there are other exclusions that may apply.

Related posts:

1. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence
2. Tax Fact 5-Refinance Debt for Improvements is Excludable
3. Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits

With the government sponsored Home Affordable Modification Program (HAMP), modifications are beginning to pick up speed which means mortgage restructuring may become a more common occurrence. Some lenders have established their own programs for modifying home loans.  Whether or not a government program is involved, any write down of the qualified principle resident’s debt can qualify for exclusion from income.

It is important to realize that debt cancellation occurs when a lender forgives a portion of its debt.  The failure to take this into consideration could result in a letter from the Internal Revenue Service demanding the payment of more tax.  Find out what to do if you get that type of letter in my article on responding to the IRS notice that you owed tax from debt cancellation income.

Related posts:

1. Tax Fact 6-Cancelled Debt From a Refinance Can Be Taxable Income
2. Tax Fact 5-Refinance Debt for Improvements is Excludable
3. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence

Debt cancellation on a principal residence can occur in a number of different ways.  The most common way people will see this occur is when there is a foreclosure.  In a foreclosure sale, the property is often sold at a value which is less than the amount of the debt.  This will cause cancellation of debt income.

Another situation in which mortgage debt forgiveness can occur is a short sale.  While that term has long been used in describing certain stock transactions, it has gained popularity in describing the sale of a property for less than the amount of debt secured against it.  When that happens, the lender is paid a “short” amount and does not get paid the remainder of the debt.  For debt cancellation to occur, the lender would have to forgive the amount it failed to receive in exchange for the release of its lien.  This type of transaction has become a common practice when lenders want to avoid the cost of foreclosure.  A homeowner is generally able to sell their residence for more money than it would bring at a foreclosure sale.

Related posts:

1. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
2. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence
3. Tax Fact 3-Debt Cancelled through Mortgage Restructuring is Eligible

It is important to note this statute only covers the principle residence or main home of the taxpayer.  A principle residence can be a house, houseboat, mobile home, co-op apartment or condominium.  Any abode that a taxpayer can call home is likely to meet the IRS standards for principal residence if that is where the taxpayer lives most of the time.  When it is a close question whether or not an abode is the principal residence of the taxpayer, the IRS will look at factors such as the following:

1. The taxpayer’s place of employment;
2. The location of the main home for the taxpayer’s family members;
3. Taxpayer’s mailing address for bills and correspondence;
4. Addresses listed in tax returns, drivers license, car registration, voter registration;
5. The location of banks used by the taxpayer; and,
6. The location of recreational clubs and religious organizations to which the taxpayer belongs.

The other important issue is the debt must be qualified personal residence debt.  To be “qualified” the debt must have been incurred to acquire or substantially improve the taxpayer’s personal residence.

Related posts:

1. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
2. Tax Fact 5-Refinance Debt for Improvements is Excludable
3. Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits

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.

Over the next two weeks, I plan to elaborate on each of the above ten  facts.  A tax bill can be an unexpected consequence to the devestation wrought from home foreclosure.  With the information on this website, and the help of one of my co-authors, you may be able to avoid home foreclosure altogether.  However, if your home loan is foreclosed, it is best to know and understand the above facts so that you can avoid tax liability when it is possible to do so.

Related posts:

1. Tax Fact 8-Mortgage Debt Forgiveness for Property Not Principal Residence
2. Tax Fact 4-Only Certain Mortgage Debt Qualifies For Exclusion
3. Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits