Tax treatment of canceled mortgage debt


Mortgage lenders sometimes cancel or forgive a person’s debt. While this relieves the debtor of immediate financial stress, it often causes a tax debt. Under tax law, canceled debt is considered income to the debtor and is included as part of the debtor’s income.

The lender reports this canceled debt both to the individual and to the Internal Revenue Service using Form 1099-C. The tax law provides three remedies for excluding canceled debts from taxes. There is an exception in the case of insolvency, for cases involving bankruptcy, and a new exclusion for certain forms of mortgage debt.

The mortgage exclusion is especially important

The mortgage exclusion is especially important

For people who are going through foreclosure, short selling or having some of their main reduced through a loan modification.

In December 2007, Congress approved the Mortgage Forgiveness Debt Relief Act. This law provides for tax relief for homeowners who lose their homes due to foreclosure or short sales or who restructure their mortgages with a lower principal amount. The law allows people to exclude $ 2 million of certain mortgage debt canceled by lenders.

There are a number of criteria that must be met to qualify for this exclusion. Canceled mortgage debt that does not meet these criteria can still be excluded using the rules for insolvency or bankruptcy.

People with home equity loans and refinancing cash-out or debt-consolidation should do some additional accounting to ensure that they can take full advantage of all the tax exclusions that apply to them.

Canceled Debt and taxable income

Canceled Debt and taxable income

Normally, the debt that is forgiven or canceled by a lender is regarded as the debtor’s taxable income. The tax laws stipulate that canceled debts are included in the result of a person and subject to taxes. For reference, the law is Internal Revenue Code Section 61 (a) (12). This law says that “the income from debt discharge” is included in a person’s gross income for the year.

The tax laws also spell specific circumstances when a person will not have to pay taxes on canceled debts. These are called exclusions, which means that the amount will not be included in a person’s taxable income.

A number of exclusions are available, but only three of them apply to the situation of the canceled mortgages. These three exclusions for:

  • Debt canceled in bankruptcy proceedings
  • Debt canceled when the person is insolvent
  • Debt that is eligible under the Mortgage Forgiveness Debt Relief Act

Each of these exclusions has its own set of criteria and reporting procedures. For people who have lost their homes, it can be crucial to collect original loan documents to show where the borrowed money was spent.

For further explanation regarding canceled debt in general, see the debt cancellation part of Publication 908 and the canceled debts part of Publication 17.

For which in the context of the Debt Relief Mortgage Forgiveness Act

For which in the context of the Debt Relief Mortgage Forgiveness Act

Mortgage debt can be excluded from income under the Mortgage Forgiveness Debt Relief Act. This law states that certain types of canceled mortgage debt can be excluded from taxes. This exclusion is important for people who have been driven out of their homes, or who have sold their homes for a short time, or who have restructured their mortgage.

There are two types of mortgage debt in the tax code: home acquisition debt and home equity debt. The distinction between the two effects in which the removal applies. Acquisition debt is debt, the proceeds of which were used to buy, build or significantly improve a principal residence. Home equity debt is debt, the proceeds of which were not used to purchase, build, or improve the residence.

Acquisition debt can be excluded from tax under the Mortgage Forgiveness Debt Relief Act. Home equity debt cannot be excluded on the basis of this new law. Instead, home equity debt can be classified under the insolvency or bankruptcy exclusions.

There is a further criterion too. The house must have been used as the main house, which means that it was the debtor’s main residence. That means second homes, vacation homes, investment property, or rental units will not qualify under this exclusion. Canceled debts for those properties may be eligible, however, under the insolvency or bankruptcy exclusions.

How much debt can be excluded from the tax? Canceled mortgage debt of up to $ 2 million (or $ 1,000,000 is married and submitting a separate return) can be excluded from income for the years 2007 to 2016. After 2016, people can still exclude the remission of their taxes, as long as the debtor and lender entered into a binding written agreement to cancel the debt no later than December 31, 2016.

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