Mortgage debt forgiveness relief FAQs

Elizabeth Rosen
by Elizabeth Rosen, Contributor

Due to the subprime mortgage crisis and the economic recession, millions of homeowners have found themselves struggling to make mortgage payments on properties that have lost much of their value. Aside from the onslaught of foreclosures, millions of people are dealing with underwater mortgages, which means that they owe more on the home than it is worth. Fortunately, many mortgage lenders have allowed borrowers to refinance their home loans, and in some cases, lenders have forgiven or cancelled part of the borrower’s mortgage loan debt.

Here are some frequently asked questions regarding mortgage debt forgiveness and the Mortgage Debt Relief Act of 2007. If you are a struggling homeowner, there may be some financial relief in sight.

What is mortgage debt forgiveness?

If you owe a debt (such as a mortgage loan, in the case of this article), the lender may choose to forgive or cancel some of that debt as part of a mortgage restructuring agreement or foreclosure. This is also known as mortgage forgiveness. However, while you may no longer owe that amount of debt to the mortgage lender, the cancelled amount may still be considered taxable by the IRS. This is because under the Internal Revenue Code, all types of forgiven debt are still treated as income and subject to taxes.

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What is the mortgage debt relief act?

The Mortgage Debt Relief Act of 2007 allows taxpayers to exclude income (on their tax returns) from the discharged debt on their principal residence. This can include debt that is reduced by mortgage restructuring as well as debt that is forgiven relating to a short sale or foreclosure.

The Mortgage Debt Relief Act applies to the following 4 situations:
• Homeowners who are granted principal forgiveness on their mortgage loan
• Homeowners who have lost their home to foreclosure, or are in the process of foreclosure
• Homeowners who do a deed-in-lieu of foreclosure on their home
• Homeowners who do a short sale on their home

When does the mortgage debt relief act expire?

The Mortgage Debt Relief Act was originally signed in 2007, and was recently extended to be effective until the end of this year (December 31, 2013). If the Mortgage Debt Relief Act had expired, any amount of forgiven debt would be considered taxable for IRS purposes.

If you are looking for mortgage debt forgiveness relief, you now have about 11 months to take advantage of this tax break. While December may seems a long ways off, bear in mind that short sales can take up to 6 months (or more) to complete. A loan modification or a deed-in-lieu of foreclosure can take over 3 months to finalize, and a foreclosure can take up to a year to conclude.

How can I get mortgage debt relief help on principal forgiveness?

In some instances, the mortgage lender may elect to cancel part of your mortgage loan debt. This is also known as “principal forgiveness,” when a lender decides to forgive a portion of your debt, or principal. (Remember that a monthly mortgage payment encompasses principal and interest, as well as property taxes and homeowners insurance.) With the Mortgage Debt Relief Act, any debt that has been forgiven by your mortgage lender can be excluded from your income and will not be subject to Federal taxation. This means that you will not have to pay taxes to the IRS on debt that you actually no longer owe.

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How can I get mortgage forgiveness help on a foreclosure?

Amidst the subprime mortgage crisis and housing market crash, many borrowers found that they could no longer afford to make their monthly mortgage payments. This could have been because of a bad financial situation (such as a job loss) or because the mortgage loan terms were automatically altered (which happens with adjustable-rate mortgage loans making the mortgage now unaffordable. When a borrower defaults on their mortgage loan, the mortgage lender has a right to initiate foreclosure proceedings on the property. On the positive side, due to the 2007 Mortgage Debt Relief Act, any debt that is forgiven in relation to a foreclosure can be excluded from your income and will not be subject to taxation by the IRS.

How can I get mortgage forgiveness help on a deed-in-lieu of foreclosure?

As an alternative to foreclosure, a mortgage lender may allow a delinquent borrower to choose a deed-in-lieu of foreclosure instead. A deed-in-lieu of foreclosure means that the borrower surrenders all interest in the property to the lender (who now takes over the property) in exchange for releasing the borrower from their mortgage debt obligation. This option helps satisfy the defaulted loan, but is often less damaging to the borrower’s credit score (than a traditional foreclosure) and it helps avoid going through the whole foreclosure process. If the deficiency balance (resulting from the sale of the property) is forgiven as part of your deed-in-lieu of foreclosure arrangement, the IRS still considers the forgiven amount as part of your income that is taxable. The Mortgage Debt Relief Act, however, allows eligible taxpayers to exclude from their income the debt that is forgiven in association with a deed-in-lieu of foreclosure.

How can I get mortgage forgiveness help on a short sale?

As another alternative to foreclosure, a mortgage lender may allow a delinquent borrower to take part in a short sale instead. With a short sale, your home is sold for less than the balance remaining on your mortgage loan, which the lender agrees to accept in order to satisfy the defaulted loan. As the borrower, you receive no money from the short sale, but you avoid having to endure foreclosure proceedings. If your mortgage lender decides to forgive the deficiency balance (resulting from the sale of your home) as part of your short sale agreement, the IRS still generally considers the forgiven amount as part of your income that is subject to tax. Fortunately, the 2007 Mortgage Debt Relief Act permits taxpayers to exclude the amount of forgiven debt from their taxable income.

Does the mortgage debt relief act apply to debt from refinancing?

Depending on your situation, debt that was used to refinance your home may qualify for this exclusion. However, this is true only to the extent that the principal balance of your original mortgage loan (immediately before you refinanced) would have qualified for the exclusion.

Does the 2007 mortgage debt relief act apply to all cancelled debts?

No, the Mortgage Debt Relief Act does not apply to all forgiven debts. It applies only to forgiven or cancelled debt that was used to purchase, build, or significantly improve your main home (i.e. principal residence). It also applies to refinance debt that was incurred for the purpose of buying, building, or significantly improving your principal residence. This type of forgiven debt, which is eligible under the Mortgage Debt Relief Act, is called “qualified principal residence indebtedness.”

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Can I exclude (from income) debt forgiven on my 2nd home, car loan, or credit card?

No, you the 2007 Mortgage Debt Relief Act does not apply to cancelled or forgiven debt associated with your second home, car loans, or credit cards. The exclusion provided under the Mortgage Debt Relief Act can only be used for cancelled debt related to the purchase, construction, or substantial improvement of your principal residence, as well as refinance debt related to those purposes.

Is there a limit on the amount of forgiven debt that can be excluded from income?

Under the Mortgage Debt Relief Act, homeowners may be able to exclude up to $2 million of cancelled debt from their taxable income (or up to $1 million if married filing separately) at the time the debt was forgiven. Keep in mind, this exclusion does not apply to debt that is forgiven for any reason that is not directly associated with your financial situation or a drop in your home’s value. If the amount of your forgiven debt is greater than the limit above, see the Instructions for IRS Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment) and IRS Publication 4681 (Cancelled Debts, Foreclosures, Repossessions, and Abandonments).

If my forgiven debt is qualified to be excluded from income, do I have to report it on my tax return?

Yes, you must report the amount of debt forgiven on IRS Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment) and attach that form to your income tax return.

If I lost money on the foreclosure of my home, can I claim the loss on my tax return?

No, you cannot deduct losses from the sale or foreclosure of personal property on your income tax return.

Will I receive notification of cancellation of debt from my mortgage lender?

Yes, you should expect to get a notification from your mortgage lender regarding the cancellation of your debt. Lenders are required to send Tax Form 1099-C (Cancellation of Debt) to the borrower if they cancel any debt of $600 or more.

How can I find out how much debt was forgiven?

You should receive a Tax Form 1099-C (Cancellation of Debt) from your mortgage lender informing you how much debt was forgiven. The amount of cancelled debt will be shown in Box 2 of this form. If all of your forgiven debt is considered “qualified principal residence indebtedness” (eligible under the Mortgage Debt Relief Act), then the amount shown in Box 2 of Form 1099-C will most likely be the amount that you enter on Lines 2 and 10b on Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment).

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Which form do I use to get tax relief for mortgage debt forgiveness?

Use IRS Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment) to claim the mortgage forgiveness tax break. On this form you can report the exclusion of forgiven debt for your mortgage loan that is associated with principal forgiveness, foreclosure, a deed-in-lieu of foreclosure, or a short sale. Note that you will only need to fill out part of Form 982 because it is also used for other purposes. Complete the appropriate lines and then attach Form 982 to your regular income tax return.

Do I have to fill out the entire form 982?

No, you do not have to complete the entire Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment) if you are only using the form to report your cancelled “qualified principal residence indebtedness” for exclusion from income (under the 2007 Mortgage Debt Relief Act). Note that Form 982 is used for purposes besides reporting the exclusion of forgiven debt on a principal residence. If you qualify for the exclusion under the foreclosure provision (of the Mortgage Debt Relief Act), you will only need to fill out Lines 1e and 2 of Form 982. If you qualify for the exclusion under the loan refinancing/modification provision (of the Mortgage Debt Relief Act), you will only have to complete Lines 1e, 2, and 10b of Form 982. Don’t forget to attach the Form 982 to your regular tax return.

Where can I find more information?

For more information about mortgage forgiveness and the 2007 Mortgage Debt Relief Act, please refer to the following documents:

IRS News Release IR-2008-17

IRS Publication 4681 (Cancelled Debts, Foreclosures, Repossessions, and Abandonments)

IRS Tax Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness, and Section 1082 Basis Adjustment)

IRS Tax Form 1099-C (Cancellation of Debt)