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The Mortgage Forgiveness Debt Relief Act of 2007 was passed in response to the rising number of Americans facing foreclosure of their primary residences. When a house is foreclosed on and the house is worth less than what is owed to the foreclosing mortgage company, the difference or deficiency is usually written off and a 1099-C is issued for the canceled debt. The reason a 1099-C is issued is because your house was foreclosed on and you did not have to pay the mortgage company the amount they lost, so you received a benefit and the government normally taxes you on the benefit.
Maybe the government (President, Congress, Senate) felt bad for not regulating the mortgage industry better. Maybe they got together with the mortgage companies and cut a deal. The government will not require you, the mortgage company or mortgage servicer to give people loan modifications, but if they lose their house we will make the government take the hit and not tax people on the deficiency or the difference between the amount the house is worth and at the time it was foreclosed on. So, they passed the Mortgage Forgiveness Debt Relief Act of 2007.
Basically the act provides that a person whose house is foreclosed on between 2007 and 2012 does not have to pay taxes on any 1099-C that is issued. The house that is foreclosed on must be their primary resident and meet other requirement. So the window for getting rid of an underwater house is closing quickly. Will the government extend the debt relief for more years? I would not count on it. You are not a multi-million dollar corporation that for some reason can get bailed out. Now is the time to seriously consider if you want to keep an underwater house and just get rid of it and move on without have a tax penalty. Your government is trying to close a trillion dollar budget gap and stop the national debt from continuing to grow and such a fast rate. This tax relief is on the chopping block and probably will not be extended past 2012.
Here are 10 facts the IRS wants you to know about Mortgage Debt Forgiveness.
- 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.
- The limit is $1 million for a married person filing a separate return.
- You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.
- To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
- Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
- Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.
- 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.
- Debt forgiven on second homes, rental property, business property, credit cards or car loans do 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.
- 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.
- 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.
Please see Form 982, IRS Publication 4681 and Form 1099-C for more information.