The Mortgage Forgiveness Debt Relief Act was made law by congress on December 20, 2007. This act offers relief to homeowners who owed taxes on forgiven mortgage debt after foreclosure or a short sale. Initially, relief was only extended through 2009, but the tax relief was extended another three years covering debts discharged through calendar year 2012.
Normally, when a lender decides to forgive a borrower’s debt, the forgiven amount is considered income and the borrower is liable for income tax. However, the Mortgage Forgiveness Act removes such tax liability and allows the borrower and lender to work together to find a solution that is beneficial to all parties. The protection is limited to primary residences (rental properties are not eligible for this tax relief).
Consulting a tax advisor is recommended to ensure a borrower qualifies. The amount of forgiven mortgage debt that may be excluded from income tax is limited to $2 million per year and $1 million for a married person filing a separate return.
The IRS Stance and Form 982
“The new law contains important provisions for struggling homeowners,” said acting IRS commissioner Linda Stiff. “We urge people with mortgage problems to take full advantage of the valuable tax relief available.”
In February 2008, the Internal Revenue Service released an article titled “Mortgage Workouts, Now Tax-Free for Many Homeowners; Claim Relief on Newly Revised IRS Form.” The article states homeowners whose mortgage debt was partly or entirely forgiven may be able to claim special tax relief by filling out FORM 982. In most cases, eligible homeowners only need to fill out a few lines on FORM 982, specifically lines 1e, 2, and 10b for relief. Visit the following IRS webpage to obtain the form.
The new law applies to debt forgiven through calendar year 2012. To qualify for tax relief, the debt must have been used to buy, build, or substantially improve the taxpayer’s principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is eligible for relief, but a tax advisor should help to make that determination.
