mortgage debt forgiveness facts

Mortgage Debt Forgiveness: Do You Qualify For Tax Relief?

You can’t talk about mortgage debt forgiveness without mentioning the 2008 real estate crisis. From 2007 to 2016, the U.S. saw 7.7 million foreclosures. Today, the rate of mortgage defaults is in decline, but we have yet to reach pre-crisis levels.

Are you one of many Americans experiencing hardship due to your mortgage? We can help. Here’s what you need to know about mortgage debt forgiveness.

What is mortgage debt forgiveness?

Mortgage debt forgiveness occurs when a mortgage lender cancels or forgives some or all of a borrower’s debt. This happens as the result of principal forgiveness on a mortgage loan, a foreclosure, a short sale, or a deed-in-lieu of foreclosure.

For example, let’s say you purchased a home and ended up defaulting on your mortgage. To recover the loss, the lender sold your home — but the foreclosure sale price was lower than the initial balance of the loan. The difference left over is a deficiency for the lender.

If you purchased your home at $200,000, for instance, and the sale price at the time of foreclosure was $175,000, the lender would incur a deficiency of $25,000.

Some lenders may try and recover this deficiency from you. Others, however, will forgive the debt and write it off as a loss. This is known as mortgage forgiveness.

As a borrower, it may be a great relief to learn that your lender is going to forgive your deficiency amount. However, debt forgiveness comes with a downside. Lenders report any forgiven debt to the IRS using the 1099-C form, and the amount may become taxable income for you.

Is forgiven mortgage debt always taxable?

The IRS doesn’t always consider mortgage debt forgiveness to be taxable income. If any of the following situations apply, you won’t have to pay taxes on your canceled debt:

  • Non-recourse loans. In the case of default, non-recourse loans restrict the lender from taking any recourse other than repossessing the property. If there is a deficiency, it is automatically forgiven and considered non-taxable.
  • Bankruptcy. If you file for bankruptcy, the canceled debt will not be taxable.
  • Insolvency. If your total debts exceed the total fair market value of your assets at the time of foreclosure, you are insolvent. As such, you can receive tax relief on the canceled debts.
  • Farm debts (some). Some farm debts are exempt, but the rules here are complex. If this applies to you, consult a tax professional.

If none of these exceptions apply to you, the Mortgage Forgiveness Act could come to your rescue.

The Mortgage Forgiveness Debt Relief Act of 2007

The Mortgage Forgiveness Debt Relief Act was signed into law in 2007. It removes tax liability for qualifying homeowners whose mortgage debt was forgiven. The original act was only active through 2009, but the IRS has extended the policy every year through 2017. A 2019 extension has not yet been approved. However, the current law applies to debt forgiven up to 2017 and even 2018 if there was a written agreement in 2017.

Who qualifies?

To qualify for debt relief, you must have used the money to buy, build, or improve your principal residence. Debt forgiveness on credit cards, car loans, rental property, and second homes does not qualify.

Further, mortgage debt can qualify whether it was reduced through mortgage restructuring or foreclosure. And if you gained proceeds through refinancing and used them to improve your principal residence, that debt can also qualify.

Also, the relief won’t apply unless the discharge is due to a decline in the home’s value or the taxpayer’s financial condition.

The regulations can be complex, so it is best to speak with a tax relief professional if you think you might qualify.

How much mortgage tax debt will the IRS forgive?

The IRS will forgive up to two million dollars on a principal residence, and up to one million for a married person who files taxes separately.

How do you claim the tax relief?

Just fill out Form 982, ‘Reduction of Tax Attributes Due to Discharge of Indebtedness.’ Attach it to your Federal income tax return for the year the mortgage debt was forgiven. For further assistance, you can refer to IRS publication 4681 or contact a tax preparation firm.

Why is the government offering this tax relief?

The IRS provides this ongoing tax relief to minimize hardships for households in distress after the 2008 financial crisis, and to prevent a recession.

How much debt has been canceled?

According to the latest data released by the IRS, $83.4 billion in canceled debt have been claimed since 2007 (source). These figures include all types of canceled debt, not just residential. However, the number of forms submitted and the amount of debt increased during the 2008 financial crisis and in the following years.

The amount of canceled debt has decreased since the peak in 2011. However, levels are still higher than before the financial crisis, which suggests that taxpayers continue to experience financial distress.

Getting started

Are going through a difficult time which has put your mortgage at risk? Do you need help understanding the details of debt forgiveness? Tax preparation firms have the training and knowledge that you need. They can help you make well-informed decisions which will put you on the path to a healthier financial future. Review and compare industry-leading tax preparation firms below.