How to Handle Your Tax Liability of Forgiven Mortgage Debt

Are you nervous about your tax liability of forgiven mortgage debt? Chances are you have nothing to worry about. Learn everything you need to know ahead of tax time here today. Did you know in certain instances mortgage lenders will forgive or even cancel your debt?

This can certainly relieve you of the financial burden, but what you may or may not think of right away that it can easily cause a tax liability. The tax law states that any and all canceled debt will be looked at as income and should be part of the debtors (you) annual income for that year it is canceled or forgiven.

The mortgage lender will be reported this canceled or forgiven debt to you and the IRS via Form 1099-C. This is when you will have to report this canceled or forgiven debt on your next tax return.

However, the tax law will give you three solutions that can exclude your canceled or forgiven debts from ever having to be on your taxes. These solutions consist of insolvency, this will happen in situations that involved bankruptcy, short sales, and foreclosures.

How to Avoid Taxes on Canceled Mortgage Debt?

Curious about how you can avoid these taxes on your canceled or forgiven debt? We briefly just touched upon this subject a few minutes ago, but let’s dive deeper into the answer of this question.

Back in December of 2007, you might have heard about the Mortgage Forgiveness Debt Relief Act that was passed by congress. This act was to provide tax relief to homeowners who were losing their homes through either short sales, foreclosures, or those who were restructuring their mortgages to get a much lower principal.

This act allowed these homeowners to exclude their forgiven or canceled debt up to $2 million.

How to Qualify Using Mortgage Forgiveness Debt Relief Act?

Now, that we have talked a little bit about the Mortgage Forgiveness Debt Relief Act, let’s talk about how you can qualify.

As we previously mentioned the law states that specific types of canceled or forgiven mortgage debt can indeed be excluded from your tax liability.

Listen closely, if you have had your home sold in a short sale, your home has been foreclosed on, or you had to restructure your mortgage.

You should first and foremost know this, when it comes to the tax code, you will find two types of mortgages: home equity debt and acquisition debt.

The difference between the two-mortgage debt will impact which exclusions will be added.

When it comes to the acquisition debt, that is debt which was used to build, buy, or improve your home. While home equity debt is debt which was NOT used to build buy or improve your home.

You should know that acquisition debt CAN be excluded from your taxes when it comes to the Mortgage Forgiveness Debt Relief Act.

You should know that home equity debt CANNOT be excluded from your taxes when it comes to the Mortgage Forgiveness Debt Relief Act.  When it comes to having home, equity excluded from your taxes, you will need to go through the bankruptcy or insolvency route.

Tax Liability of Forgiven Mortgage Debt

Now, you are wondering what in the world is your tax liability for this forgiven debt under the Mortgage Forgiveness Debt Relief Act?

This will go into detail, only IF you got approved under the act. If your debt or canceled mortgage was under $2 million, it will be excluded from your income between 2007 to 2016. Then in 2017 and beyond, you can still have your debt excluded, if you and your mortgage lender have a written binding agreement to cancel your debt, but it had to have been done no later than December 31, 2016.

How Do I Report My Cancelled Debts on My Taxes?

Any canceled or forgiven debts done by your mortgage lender will still need to be reported on your tax return at the end of the year no matter what. However, it is going to be HOW you report them, whether you are eligible for any or all the exclusions available.

Your mortgage lender will submit to the IRS and send you a copy of the Form 1099-C. This will have your forgiven or canceled debt listed on it with the amount. You can find the amount of debt that was forgiven or canceled in box 2 on the form.

If you were one of those people who lost their homes due to a foreclosure, short sale, or another settlement procedure, then the amount you see is going to be for the loan principal that was not paid during the settlement. You can locate Box 5, which will show the description of the debt, such as the address of the home that had the loan. Then in Box 7 you will see the fair market value of the home in question.

In the situation of a foreclosure, the net bid price that came directly from the foreclosure sale will be used for the fair market value.

However, you will need to follow the following steps to properly and accurately report your canceled or forgiven mortgage debt on your current tax return:

  • On Form 1040 Line 21, you will need to list ALL canceled or forgiven debts that were not excluded
  • If some or all of the debts were excluded, then you will be required to fill out Form 982
  • Using Form 982, you will need to state which exclusions applied to your situation on line one. If you have more than one exclusion, you will need to fill out Form 982 for every exclusion.
  • If using bankruptcy or insolvency for your exclusions, you will be required to make some adjustments to your other tax figures. In order to do so, you will need to brush up on Publication 908.

If you were able to keep your home, but you had to restructure your mortgage, then on line 1e, you will need to check the box. On line 2, you will have to report the income. You will have to report the same income again on line 10b.

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