Yes, the economy is periodically showing some signs of improvement but it is clear the country has a long slow up hill climb ahead before most of us feel the worst is behind us. This is particularly true for families still struggling with what to do with their real estate mortgages when the value of their property is no where close to what they owe on it.
In these situations more and more property owners are finding it makes more sense to take the hit to their credit reports and walk away from the offending property and let the mortgage holder deal with the loss. Setting aside the ethical discussion surrounding this, if you do have mortgage debt forgiven you walk into a whole new complex tax arena. If you're not careful and plan appropriately
If your mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, you may be able to claim special tax relief and exclude the debt forgiven from your income. Here are 10 facts you should know about Mortgage Debt Forgiveness and what may happen to you tax-wise.
- Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.
- The limit is $1 million for a married person filing a separate return.
- 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.
- Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
- Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.
- 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.
- Debt forgiven on second homes, rental property, business property, credit cards or car loans does 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.
- 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.
- 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.
What is actually just as important about getting some mortgage debt relief is checking to be sure you fully understand and consider the possible tax bill you can create for yourself. This is one of those areas where you really are taking a big risk not having us, your CPA or attorney review your situation.
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