With the difficult economy that has existed for the last several years many homeowners have found they were struggling to make their mortgage payments due to of loss of income because of reduced work or a job loss. Still even more homeowners when faced with declining property values lost most if not all of their equity becoming upside down in their mortgages, meaning they now owed more on their home than it was worth. This combination of circumstances contributed to a housing crisis that saw a record number of defaults and foreclosures. While many breathed a sigh of relief receiving loan modifications, approvals for short sells or loan forgiveness they were now faced with another financial problem, owing income taxes on the amount of debt forgiven. Under the Internal Revenue Code any discharged debt is considered Cancellation of Debt Income, and must be included in a taxpayer’s gross income.
In an effort to encourage homeowners to work toward solutions with lending companies rather than simply walking away and adding to the housing crisis, Congress passed the Mortgage Forgiveness Debt Relief Act in December of 2007. The act allowed cancelled acquisition debt of a primary residence to be exempted from being counted as income for tax purposes. What this means is if a lender writes off $100,000 of debt in order to modify the mortgage loan or approve a short sale, the borrower would have been taxed on that $100,000 at regular income tax rates just as if they had earned it as wages. With the relief up to two million dollars of Cancellation of Debt Income is exempt as long as the taxpayer meets certain income requirements and the forgiven debt is from the acquisition of your main residence. If the debt is from forgiveness of a home equity loan for any other purpose then home improvements, or from a mortgage on a vacation residence, rental or business property it does not qualify for the exemption. Every person receiving debt forgiveness will receive a 1099 C-Cancellation of Debt form from the lender. In order to find out if your cancelled debt qualifies for the exemption take this form to your tax professional.
The Mortgage Forgiveness Debt Relief Act originally only covered the three year tax period from 2007 to 2009. In 2009 it was extended an additional three years through 2012 with the Emergency Economic Stabilization Act of 2008. Because of the continued economic and housing market troubles, and the fact that in some hard hit areas short sales still account for almost 45% of all home sales, Congress extended the act for an one additional year in the last moment fiscal cliff legislation the American Taxpayer Relief Act of 2012.