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The American Foreclosure Crisis and Forgiven Debt—relief at Last!

 

I’ve had a lot of clients worried about the foreclosure crisis lately. Clients who lost their homes are terrified of the tax repercussions of their once-expensive home selling for a pittance; then the mortgage lender turning around and issuing them a IRS Form 1099 for the forgiven debt. Imagine the horror– You’ve already lost your home to foreclosure— and now you have to pay thousands of dollars in taxes on the forgiven debt, too! The worst possible scenario!

 

Do not despair– all is not lost. Congress signed the Mortgage Forgiveness Debt Relief Act in 2007 to help the millions of homeowners who are dealing with this crisis. The Mortgage Forgiveness Debt Relief Act allows homeowners to exclude the forgiven debt from their foreclosed home, and saves already distressed homeowners from the additional blow of forgiven debt on their tax return.

 

Usually, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. The lender essentially has to “eat the cost” of the difference between what the homeowner owes on the property and what the bank eventually sells the distressed property for.

 

The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude certain cancelled debt on your principal residence from income. The Act applies to cancelled debt used to buy, build or improve your principal residence. The Act applies to homeowners whose loan was less than $2 million. The Act does not apply to second homes, rental property, or other investment property. The Act applies to debt forgiven in 2007, 2008 or 2009.

 

The cancelled debt listed on your Form 1099 still must be reported on your tax return, even though it will not be taxable. The amount of debt forgiven must be reported on Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness). This Form 982 must be filled out and attached to your tax return.

 

Form 982 is used for other purposes in addition to reporting the exclusion of forgiveness of qualified principal residence indebtedness. If you are using the form only to report the forgiven debt on a  principal residence, you only need to complete lines 1e and 2. If you kept ownership of your home and modification of the terms of your mortgage resulted in the forgiveness of qualified principal residence indebtedness, complete lines 1e, 2, and 10b.

 

Your lender should send a Form 1099-C, Cancellation of Debt, by January 31, 2008. The amount of debt forgiven or cancelled will be shown in box 2. If this debt is all qualified principal residence indebtedness, the amount shown in box 2 will generally be the amount that you enter on lines 2 and 10b, if applicable, on Form 982. 

 

And more good news– even if part of the forgiven debt doesn’t qualify for exclusion from income under this provision, is it possible that your forgiven debt will qualify under the IRS’ “insolvency” exclusion. If you believe you qualify for debt exclusion under the IRS’ “insolvency” exclusion, it is recommended that you see a tax professional to help you.

 

I hope this article has eased your fears about this crisis that so many Americans are facing this year. As long as you keep good records and fill out the proper forms for the IRS, you can breathe easy and know that your will not suffer an additional hardship from cancelled debt on your primary residence.

 

Christy Pinheiro, EA is an Enrolled Agent and holds a Bachelor’s degree from San Jose State University. She has over 15 years of business and accounting experience. She was a staff accountant for a private CPA firm and also for the State of California before going into private practice. Her finance and tax articles have been published in numerous periodicals. She is the author of Pineapple Guides’ EA Exam Review book series.
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