If your mortgage debt is partially or entirely forgiven during tax years 2007 through 2012, you may be receiving a 1099-C in the mail. Regrettably, this is a phone call from my clients I have to field on a regular basis and they are oftentimes terrified that now after going through the nightmare of home foreclosure or short-sale, they may now be paying tax on ‘debt forgiveness’.
However, not all is lost, you may be able to claim special tax relief and exclude the debt forgiven from your income. Here are 5 facts the IRS wants you to know about Mortgage Debt Forgiveness.
1. What is a 1099-C. If you had debt forgiven or eliminated during the past year, normally you 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. Generally debt forgiveness results in taxable income that must be claimed on your tax return.
2. Primary Residence. Under the Mortgage Forgiveness Debt Relief Act of 2007, you can exclude up to $2 million of debt forgiven IF it was to purchase your principal residence. The limit is $1 million for a married person filing a separate return. Also, you may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
3. Refinanced Debt. Refinanced debt may or may not be taxable, it depends on what the money was used for. Proceeds used for the purpose of substantially improving your principal residence will qualify for the exclusion. However, proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt or buy a rental property will not qualify for the exclusion.
4. Second homes and Rental Property. Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision under the Mortgage Forgiveness Debt Relief Act of 2007. However, in some cases, other tax relief provisions – such as showing insolvency, or claiming bankruptcy may allow a taxpayer to avoid claiming the debt forgiveness as income. .
5. Obtaining the Exclusion. If you qualify, to claim the special exclusion a taxpayer must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to their federal income tax return for the tax year in which the qualified debt was forgiven. IRS Form 982 provides more details about these provisions.
As you can imagine, this is not something to trifle with and this may not be the year to try and do your tax return yourself. 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.
Most importantly, retain a CPA that understands this issue to assist you in the preparation of your tax return. Remember, this too will pass. What doesn’t kill you will make you stronger.
Mark J. Kohler, CPA, Attorney at Law and Author of the Best Selling Book Lawyers are Liars- The Truth About Protecting Your Assets and his new book What Your CPA Won’t Tell You. For more information visit www.markjkohler.com.