Mortgage Forgiveness Debt Relief Act

The IRS reassured homeowners that, although mortgage workouts and foreclosures can have tax consequences, special relief provisions can often reduce or eliminate the tax bite for financially strapped borrowers who lose their homes.

For those taxpayers who find they owe additional tax , it also includes a form they can use to request a payment plan with the IRS. In some cases, eligible taxpayers may qualify to settle their tax debt for less than the total amount due using an offer-in-compromise.

The IRS urges struggling homeowners to consider their alternative solutions carefully before giving up their homes through foreclosure.

Under the tax law, if the debt wiped out through foreclosure exceeds the value of the property, the difference is normally taxable income. But a special provision allows insolvent borrowers to offset that income, to the extent their liabilities exceed their assets.

The IRS {{{cautions | warns}} that, under the law, relief may be limited or unavailable in some situations where, for example, part or all of a home was used for business or rented out.

Borrowers whose debt is reduced or eliminated receive a year-end statement (Form 1099-C) from their lender. By law, this form must show the amount of debt forgiven and the fair market value of property given up through foreclosure. Though the winning bid at a foreclosure auction is normally a property’s fair market value, it may not necessarily reflect its true value in some cases.

The IRS urges borrowers to check the Form 1099-C carefully. They should notify the lender right away if any of the information shown on their form is incorrect. Borrowers should pay particular attention to the amount of debt forgiven (Box 2) and the value listed for their home (Box 7).

The IRS also reminds lenders of their obligation to provide accurate information on the Form 1099-C. By law, the lender must send a copy of this form to the IRS. IRS follow-up contacts with taxpayers involved in foreclosure are based largely on the information reported on this form, and whether it conflicts with information provided by the taxpayer on their federal income tax return.

The IRS normally initiates these follow-up contacts by sending the borrower a notice. The tax agency urges borrowers with questions to call the phone number shown on the notice. The IRS also encourages borrowers who wind up owing additional tax and are unable to pay it in full to use the installment agreement form, normally included with the notice, to request a payment agreement with the agency.

Cancelled debt from commercial mortgage lenders is often included as taxable income on your federal income taxes. The Mortgage Debt Relief Act of 2007, however, allows some taxpayers to exclude debt forgiven on their primary place of residence. Debt that qualifies for the relief includes debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). This provision applies to debt forgiven between the years 2007 through 2012. The taxpayer must have used the debt to buy, build, or substantially improve the taxpayer’s primary residence. Debt used to refinance qualifying debt is also eligible for the exclusion up to the amount of the old mortgage principal prior to the refinancing. Debt forgiven on second homes, rental property, business property, credit cards, or car loans does not qualify for the new tax-relief provision. In some cases other kinds of tax relief, based on insolvency (or inability to finance debt) may be available. Taxpayers will receive an official statement from their lender indicating the amount of debt forgiven. The tax payer must then fill out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness which indicates the type and amount of debt forgiveness to be reduced from gross income, and submit it with their tax return.

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