What Mortgage Forgiveness Means For You

President Bush signed a law that is meant to help homeowners who are facing foreclosure or who sell their homes in a short sale. Before this law, the Mortgage Forgiveness Debt Relief Act of 2007, if your bank or lender forgave a portion of your mortgage debt because the value of your home had decreased, the IRS treated the forgiveness as taxable income. That meant that if your mortgage lender forgave $15,000 in mortgage debt because your house was worth $15,000 less than your remaining mortgage balance, the IRS treated it as earned income. When you filed your taxes, you were required to add that amount to your annual income and pay taxes on it at your regular tax rate. Just when you most needed a break, you ended up owing taxes on $15,000 in phantom income.

Under the Mortgage Forgiveness Debt Relief Act, taxpayers can exclude up to $2 million of forgiven mortgage debt on their principal residence in 2007, 2008 or 2009. If you're married filing separately, you can exclude up to $1 million in forgiven debt from your income.

What is mortgage forgiveness?
Mortgage forgiveness is a term that has become more familiar in the real estate market over the past couple of years. In essence, anytime that a lender accepts less than the full amount of the debt owed in full payment of a mortgage, the difference between the amount owed and the amount accepted is "forgiven".

Let's take a look at Sue and Jim. They took advantage of a great adjustable rate mortgage to buy a home for $350,000 four years ago. The payments were manageable until the adjustable rate did what adjustable rates do - and thanks to the changes in the housing market and the sub-prime lending market, they are now facing foreclosure. To make things even worse, the best offer that they can get on the home for which they paid $350,000 is $275,000. Although they still owe $330,000 on the mortgage, their lender agrees to accept the $275,000 as full payment of the remainder of the mortgage, forgiving $55,000 of the debt.

Under the Old Rules The IRS Gets Their Cut
When a bank or other mortgage lender forgives your loan or any part of it, they send you a 1099C in the amount of the debt forgiven. You are then required to count the amount on the 1099C as taxable income along with your earned income and wages. Sue and Jim from the paragraph above would have got a 1099C from their old lender. When they file their taxes for the year, that $55,000 would be added to their earned income, adding the insult of having to pay taxes on income they never saw. Instead of relief, they'd end up owing the IRS a hefty chunk of change at the next tax term.

The Mortgage Forgiveness Debt Relief Act Changes Everything
Well, not exactly everything. If you're forced into a short sale, you'll still get a 1009C from your lender, and you'll still have to file that with your taxes. Now, however, you're allowed to exclude the forgiven amount up to $2 million ($1 million if you're married, filing separately) from your taxable income. In other words, while it's still counted as income, you won't have to pay taxes on that amount of your income.

Who Qualifies for the Mortgage Forgiveness Debt Relief Exclusion?
According to the IRS, you'll qualify for this tax exclusion whether you mortgage debt is forgiven as part of a refinancing or if it's forgiven in connection with a foreclosure. In order to qualify for the exclusion, the following conditions must apply:

  1. The debt forgiven must be on a mortgage for your principal residence. The principal residence is qualified based on the amount of time that you lived in it over the past five years.
  2. The mortgage forgiveness must be because of loss of value in your home or because of a forced short sale in connection with a mortgage foreclosure. A forgiveness that is given in return for services performed for the lender is not allowed.
  3. The debt must be forgiven between January 1, 2007 and January 1, 2010.
  4. The debt forgiveness must be on the mortgage used to buy your home.

How to Claim the Debt Relief Exclusion
In order to claim the debt relief exclusion, you'll need to show the IRS how much of the debt has been forgiven. That will require some calculation on your part, because the IRS wants to see the fair market value of your home as well as the amount of your mortgage that was forgiven. Often, when the lender makes out the 1099C or 1099A, they may just put the value of the loan in the field that's reserved fair market value of the home. In some cases, the 1099C or 1099A may not include the fair market value at all.

Like your math teacher, the IRS wants to see your work. When you submit your taxes, you'll need to include documentation of the fair market value of the home as well as your calculations. If the fair market value of your home - the price that it was sold for - is not listed on the 1099C form, you may do best to hire an appraiser to document the fair market value.

The calculations can get complex if you've taken out home equity loans or a second mortgage on your home as well as the primary mortgage. In this case, special considerations may apply. For instance, the income exclusion only qualifies for "acquisition indebtedness"- money that's spent to buy your home, build a new home or that you use to make substantial improvements to your home.

Suppose you bought a house 10 years ago and paid $80,000 for it with a 100% loan. The Florida land boom was very good to you, and five years later your home had increased in value to $200,000. You took advantage of lower interest rates to do a cash-out refinance for $150,000, paid off the remainder of the original mortgage and pocketed $70,000. When time comes to sell, though, you can only get $100,000 for the property and your lender agrees to a short sale because the home has decreased in value, forgiving $50,000 of the loan amount. Can you use the Mortgage Forgiveness Debt Relief Exclusion to avoid taxes on the $50,000?

That depends, says the IRS, on what you did with the cash-out part of the loan refinance. If you used the money from the refi to pay college tuition or your daughter's wedding, then you'll have to pay taxes on the forgiven amount. If, on the other hand, you used it to make major improvements to your home, then it qualifies for the exclusion - but you'd better be able to prove the expenditures. If you're audited, you may need to provide your original warranty deed, or your HUD-1 form. You may need to show canceled checks, receipts and invoices to show the cost of improvements you made.

Filing For the Debt Forgiveness Exemption
The new law came at the end of the year, after the tax forms for this year had been printed, so you won't find anywhere on the tax forms to make the calculations you'll need to prove you qualify for the exemption. The IRS is suggesting that those who are facing a short sale or foreclosure this year use electronic tax preparation software. The private software companies have worked hard to update their own forms so that you can do all the necessary calculations within the software, then print out the results so that you can attach them to your completed tax return.

Source - Calum MacKenzie is Owner of Real Living Southern Homes a residential real estate brokerage located in Wesley Chapel, Florida and also serving the Tampa real estate and Land O' Lakes FL real estate markets. http://activerain.com/blogsview/371563/What-the-Mortgage-Forgiveness-Debt-Relief-Act-Means-For-You

About the Author...
This Mortgage Forgiveness Information was provided by Christina Asad Edwards, a Nationally recognized leader in her field. Christina can be reached via email at Christina.Asad@RealLiving.com or by cell phone or text message at 937-205-4741. Christina has helped thousands of people move in and out of the Dayton Ohio area and other Southwest Ohio towns. For Ohio Real Estate and homes see Dayton Ohio Real Estate.

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Blog article provided by Christina Cavins, a Nationally recognized Realtor with Irongate Inc. Realtors. Christina can be reached via email at ChristinaCavins@aol.com or by cell phone or text message at 1-937-205-4741. For Ohio real estate and homes see Ohio Real Estate.


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Comment balloon 2 commentsChristina Cavins • April 28 2009 08:06PM


Christina, good food for thought. That was a great piece of legislation.

If anyone has had debt cancelled, I encourage them to NOT try to do their own taxes. This is something that should be prepared by a professional tax preparer (e.g., H&R Block) or CPA.

Debt Cancellation is a minefield. The 1099 C and 1099 A are two different animals with regard to reporting debt cancellation, and timing.

And, your state tax laws may not be in synch with the Feds. While the debt may NOT be income on the Federal return, it MAY still be taxable income at the state level.

Depending on the circumstances of the sale, the cancelled debt may be excluded as taxable income for reasons other than the Mortgage Debt Relief Act.

Posted by Andrew Haslett, Heartland of Kentuckynulls, Best Home Inspector (Van Warren Home Inspections, NAHI CRI) over 11 years ago

What a great article. Just the type of information we need to get to our clients

Posted by Joe Jackson, Clintonville and Central Ohio Real Estate Expert (Keller Williams Capital Partners Realty) about 11 years ago