The Mortgage Debt Relief Act of 2007, and H.R. 3648

The Mortgage Forgiveness Debt Relief Act and Debt Cancellation commonly known as The Mortgage Debt Relief Act of 2007, and H.R. 3648, is set to expire at the end of 2012 and could have a significant impact on you financially and hamper your ability to quickly recover from a short sale, loan modification or foreclosure.

If you are a homeowner whose mortgage debt may be partly or entirely forgiven, you may be able to exclude the forgiven debt from your income if you take the loss by 12/31/2012. Normally, the amount of debt forgiven by the lender must be reported on your tax return as income. But because of a special tax relief program that is set to expire at the end of 2012, generally, you will not have to report as income mortgage debt on your home that was forgiven or reduced by the lender. This includes mortgage debt that was forgiven in foreclosure and debt reduced through a mortgage workout, short sale, or foreclosure.

Ten Facts for Mortgage Debt Forgiveness
Source - IRS Tax Tip 2011-44, March 3, 2011

Here are 10 facts the IRS wants you to know about Mortgage Debt Forgiveness.

   1.  Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able 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 do 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.

   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.

Mortgage Debt Cancellation Relief - H.R. 3648 - Public Law 110-142 General Information and Provisions

Individuals who are relieved of their obligation to pay some portion of a mortgage debt on a principal residence between January 1, 2007 and December 31, 2012 will not be required to pay income tax on any amount that is forgiven.

General Provisions of Public Law 110-142:

No income limitation: All borrowers receive the relief, no matter what their income.

Dollar limitation: No more than $2 million of mortgage debt is eligible for the exclusion ($1 million of debt for a married filing separately return).

Relief applies only to an individual's principal residence.

The forgiven mortgage debt must have been secured by that residence.

No relief is available for cash-outs, whether the cash-out takes the form of a refinanced first mortgage, a second mortgage, home equity line of credit or similar arrangement.

Eligible debt is what is called "acquisition indebtedness." This is debt used to acquire, construct or rehabilitate a residence.

Refinanced debt qualifies, so long as the debt does not exceed the original amount of the debt. (Same rule as Mortgage Interest Deduction)

Home equity debt (or second mortgages) qualifies if the funds were used to improve the home. (Borrower must have adequate records, as under current law.)

See cash-outs, above. No amount of a cash out may be treated as acquisition debt.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit http://www.irs.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments.

You can also use the Interactive Tax Assistant available on the IRS website to determine if the cancellation of debt is taxable. The ITA tool is a tax law resource that takes you through a series of questions and provides you with responses to tax law questions

Taxpayers may obtain copies of IRS publications and forms either by downloading them from http://www.irs.gov or by calling 800-TAX-FORM (800-829-3676).