The following are the most commonly asked questions and answers about The Mortgage Forgiveness Debt Relief Act and debt cancellation. This information should not serve as tax advice. You are encouraged to seek the advice of a qualified tax advisor when preparing or reviewing tax forms.

What Is Cancellation of Debt?

If you borrow money from a lender, and the lender later cancels or forgives the debt, you may be liable for income taxes on that amount. This all depends on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income, because you had an obligation to repay the lender. When that obligation is forgiven, the canceled debt is normally considered income, because you no longer have an obligation to repay the lender. The lender is required to report the amount of canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which is generally taxable income to you.

Is a Cancellation of Debt Always Taxable?

There are some exceptions. The following examples explain the most common situations where canceled debt is not taxable. All of the exceptions are discussed in Publication 4681 from the IRS. Contact a qualified tax advisor to fully understand these exceptions and how they apply to your situation.

1. Qualified principal residence indebtedness: This exception was created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
2. Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
3. Insolvency: If you are insolvent when the debt is cancelled, some or all of the debt may not be taxable. You are insolvent when your total debts are more than the fair market value of your total assets.
4. Non-recourse loans: A non-recourse loan eliminates borrower liability. The lender’s only default remedy is to repossess the property being financed or used as collateral. The lender cannot pursue the borrower personally. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

How Do I Report Forgiven Debt to the IRS?

The amount of debt forgiven is reported on FORM 982 and this form is attached to your tax return. To obtain FORM 982, speak with your CPA. Individuals can also download the form at IRS.gov or call 1-800-829-3676. If you call to order, please allow 7-10 days for delivery.

How Do I Know How Much Debt Was Forgiven?

Your lender should send a Form 1099-C if they choose to forgive and write off the deficiency amount. The amount of debt forgiven is shown in box 2 on the form. The Mortgage Forgiveness Debt Relief Act provides tax relief on the amount shown in box 2. Use FORM 982 and complete lines 2 and 10b and report to the IRS.

Money Lost through Foreclosure; Can I Claim a Loss on My Tax Return?

Losses from the short sale or foreclosure are not deductible. These losses are not tax deductible and any improvements, down payments, etc., are lost.

After a Short Sale, the Remaining Loan Balance Is Forgiven. Is that Cancellation of Debt?

Cancelled debt occurs when a loan is not fully satisfied and the unsatisfied debt is cancelled. If the amount forgiven is $600 or more, the lender must issue a Form 1099-C, Cancellation of Debt. If you do not receive a 1099, contact your lender. If the 1099 isn’t correct, contact your lender to work out any discrepancies and have the form corrected.