Taxes and a Load off Your Debt, Or is It?

Rick_E_Norris_An_Accountancy_Corporation_Taxes_and_A_Load_Off_Your_Debt_Or_Is_ItLosing your home is bad enough, but paying taxes because the experience rubs salt in the wounds.  Prior to 2007, there was very little relief for a debtor that had a residence debt forgiven.  However, that changed in 2007.  Canceled debt is normally taxable to you, but there are exceptions. One of
those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

Here are some points I found on the IRS web site regarding the tax implications and considerations:

1. 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.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. 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.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does 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. However, I have found that some clients that have lost  rental property with a high basis may have a chance of offsetting the gain with the rental’s basis.

9. 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.

10. 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.

If the bank forgave your debt, do not wait until April the next year to tell your tax advisor.  Sometimes, proper tax planning can help reduce the pain.  Discuss your situation with a tax advisor before making any decisions.

______________________________________________________________________________

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the U.S. Department of the Treasury and Internal Revenue Service, we inform you that any tax advice contained in this e-mail (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or state tax authority, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Leave a Reply

Your email address will not be published. Required fields are marked *

Call Us (310) 216-7632 or

Send Message

Send Message