Homeowners caught in the topsy-turvy flip-flop of the housing market who now find themselves underwater with a mortgage they cannot afford, may find some debt relief with the Mortgage Forgiveness Debt Relief Act. According to the Internal Revenue Service (IRS):
Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence.
Debt Cancellation Overview
You borrow money from a lender that you ultimately don’t repay. That lender later cancels or forgives the debt. You may owe taxes because you are no longer obliged to repay the lender all the money you borrowed.
Simply put, you borrow $20,000. You repay $8,000. The lender is unable to collect the balance, so she cancels the debt of $12,000. Generally, that $12,000 (which you received and spent) is now considered income and is, therefore, taxable to you.
However, there are exceptions. All our part of your debt income is not taxable for:
- Qualified principal residence indebtedness (debt secured by your home)
- Certain farm debts
- Non-recourse loans
The Mortgage Forgiveness Debt Relief Act
Normally, when you have a debt to someone that is cancelled or forgiven, you have to pay income taxes on the cancelled amount. However, the Act generally provides relief to homeowners who reduce their debt through mortgage restructuring or have it entirely forgiven after a foreclosure, if the home involved is your principal residence.
The loan on your home must be to “buy, build, or substantially improve your principal residence, or to refinance debt incurred for those purposes.”
This forgiveness applies only through the end of 2012. For more information on the Act, visit the IRS website.