Learn More About the Mortgage Forgiveness Debt Relief Act

How does the Mortgage Forgiveness Debt Relief Act work? What are the qualifications? What forms do we file with our taxes?

My wife and I purchased a home in 2005. The interest rates shot up out of control and needless to say we lost our home in 2009. We are filing our taxes for 2009. At first when we filed we were told we owned $35,000 to federal and state. I did some research and came across the Mortgage Forgiveness Debt Relief Act of 2007. The problem is we had a duplex. Does the debt relief act of 2007 protect home owners who lived in rental properties they owned? The loan balance was $167,900 and the bank sold the property for $30,600.

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  • Review the tax implications for forgiven debt.
  • Submit IRS Form 982 in a timely manner.
  • Consult with a tax professional, whenever a question of forgiven debt arises.

Under federal law, a financial institution is required to file a Form 1099-C whenever it forgives or cancels a loan balance greater than $600. This may create a tax liability for the debtor because the canceled debt is considered “income” for tax purposes.

However, the Mortgage Forgiveness Debt Relief Act of 2007 provides tax relief for some mortgage loans forgiven in 2007 through 2012. The Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence.

Editor’s note

The Mortgage Forgiveness Debt Relief Act was originally scheduled to expire at the end of 2012, but Congress and the President acted to extend it through 2013. It remains to be seen if they will act again and extend the protections through the end of 2014.

Regarding your question about the duplex qualifying, I can find no indication in the tax code that would disqualify a duplex from the Mortgage Forgiveness Debt Relief Act if half of the duplex was purchased for and used as your household residence.

The Mortgage Forgiveness Debt Relief Act of 2007 includes the cancelation of the complete debt. If the mortgage terms were renegotiated, up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). According to the IRS, the exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

IRS Form 982

The amount of debt forgiven must be reported on Form 982 and this form must be attached to the taxpayer’s tax return.

You qualify for the Mortgage Forgiveness Debt Relief Act if the home was your principal residence. If so, be sure to report the canceled/forgiven amount on Form 982, and include that form with your income tax return. See the IRS document “The Mortgage Forgiveness Debt Relief Act and Debt Cancellation” for more information. Whenever a Form 982 is required, I recommend that professional tax help is used to ensure the form is filled out properly.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

151 Comments

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  • KH
    Jan, 2013
    Kevin
    Make sure you share with Arizona homeowners that the MFDRA had little impact on Arizona residents. There are many homeowners who may not fit into the MFDRA and still may not have cancellation of debt tax liability in a short sale. Check out the article Why The Mortgage Debt Forgiveness Act Rarely Applies To Arizona Homeowners to learn more.
    0 Votes

    • BA
      Jan, 2013
      Bill
      Thank you for sharing the link to the thoughtful article, Kevin. From my reading, Arizona homeowners with purchase loans should verify whether they have a non-recourse loan. Many of them will not be affected by the extension of the MFDRA.

      However, Arizona borrowers who refinanced their purchase loans could benefit from the extension.
      0 Votes

  • KD
    Dec, 2012
    Karen
    I am considering a Deed in Lieu of Forclosure on a commerial property in Florida instead of forclosure. I (not a bank) hold the mortgage. The owner is way behind on payments to me as well as property taxes and is considering filing bankruptcy. Is this a good option? Will he be liable for taxes? Any other considerations?
    0 Votes

    • BA
      Dec, 2012
      Bill
      If I understand the facts you shared correctly, you are the lender for a Florida commercial property, and the borrower is hopelessly delinquent. The borrower confided with you his or her idea of filing bankruptcy, and you want to know if a deed in lieu of foreclosure is a good idea. It is clear you are the lender, but it is unclear if your loan is secured by the commercial property. Let's tackle the easy questions first.

      First, you ask this question on a page discussing the Mortgage Forgiveness Debt Relief Act, which does not apply to the borrower here because you mentioned the property is commercial. The Mortgage Forgiveness Debt Relief Act applies to residential property, and not commercial. Second, unless Congress and the President act, the Mortgage Forgiveness Debt Relief Act will expire at the end of 2012.

      You asked about the borrower's tax liability. I see two tax issues here. First, the unpaid property taxes are significant because if the borrower does not pay the property taxes, the county may file a tax lien or even foreclose to collect the amount due. Should it foreclose and you not take action, it could evict any tenant and auction the property, subject to any other encumbrances on the property, such as your mortgage. The second tax issue is also tricky. I will assume you as the lender are not in the business of lending money — you are not a banker. If so, you are not required to issue the borrower a 1099-C. However, I confess I do not know if you are allowed to issue a 1099-C. Consult with a tax lawyer to learn more about the tax implications for you if you are allowed to issue the borrower a 1099-C.

      Finally, your hardest question — is a deed in lieu of foreclosure a smart choice for you. This is impossible to answer without knowing more about your financial circumstances and what an outsider can know about the borrower's finances. If he or she files for bankruptcy, you and all of his or her other creditors are subject to the decisions of the debtor's bankruptcy trustee. If you and the borrower agree to a deed-in-lieu-of-foreclosure, the borrower may not need to file for bankruptcy, and you might be able to work out a better deal than the bankruptcy court dictates.

      Consult with a lawyer in Florida who has real property or contract law experience to learn more about your rights, liabilities, and options.
      0 Votes

  • JC
    Apr, 2012
    Joann
    Have a home in foreclosure in the state of Vermont and am awaiting my first hearing after the mediation was unsuccessful. I have been renting the home and living in a different state since 4/2008, with only short stays at the property since. My rental income has been reported each year since. I defaulted on the loan in Oct 2008 and have applied for several loan mods which were denied. Now I'm in way too far over my head and am looking at a default of almost $100,000 due to the long, drawn out process. My current loan was a refi to consolidate debt and pay for some house repairs (no receipts). I believe there could be a problem with the deed and did ask for proof of ownership on the banks part in my answer to the court. I am currently not represented by a lawyer.

    I defaulted due to a disability and have been receiving SSDI as of mid 2010. I have made a minor amount of rental income in the years prior and owed no income tax. My question is - am I running a risk of tax liability if I do not have this settled by the end of this year? Will my deficiency be taxed by the IRS if I am disabled? Is there any other option to avoid a deficiency other than a short sale? I am concerned about a short sale due to the chain of transfers and MERS recorded deed. Thanks!
    0 Votes

    • BA
      Apr, 2012
      Bill
      The Mortgage Forgiveness Debt Relief Act is a wonderful law that helped soften the blow of foreclosure. However, it is not the only tool available to people should Congress fail to act and extend MFDRA. See the Bills.com resource Cancellation of Debt Income to learn about CODI, which might help you.

      Congress has a handful of laws to help people with disabilities. For example, there is a tax deduction available for the blind. I know of no law giving a waiver for loan forgiveness, or altering mortgage-related taxes for disabled people. Readers, please offer your reference to these types of laws by clicking on the Reply button below and share what you know.
      0 Votes

  • MN
    Apr, 2012
    Michelle
    I foreclosed on a property in April of 2010 it was my primary residence at the time. GMAC that year sent me a 1099 A and they have repeatedly told me that they do not pursue a difficulty which i don't even know if there was one per the 1099 the fair market value was more than what i owed but i am not sure what they sold it for. Should I be worried that they did not send me a 1099 C? I have asked for some sort of letter stating that the account is closed but i have had no luck except for a verbal notification from various reps that the account is closed and that I owe nothing and that GMAC will not now nor in the future pursue any kind of deficiency. They have told me to call the law office that i guess drafted paperwork on the foreclosure, which i have and they say that the case is closed on my property and any kind of letter would have to come from GMAC...I do plan on buying again when I can and I just don't want this lingering over me that some day I can have a lien put on my house or be sued by GMAC?

    I also had a second mortgage with Chase I am settling with them now. I will be submitting payment to them this week to close my account and to have no further debt obligation with them. Does the 2nd mortgage that i had fall under the debt relief Act or is it only for the senior loan which would be GMAC. Chase has discharged about $27,000 that i would have owed and now i am not sure if i will have to pay taxes on that difference. Any advice would be very much appreciated.
    0 Votes

    • BA
      Apr, 2012
      Bill
      You have two issues regarding the senior, GMAC deficiency balance.
      1. Can GMAC file an action to collect the deficiency balance? In other words, what is the statute of limitations for a deficiency balance in the state where the property was situated? Consult with a lawyer in the state where you owned the property to get an answer to that question. Tell him or her about the spoken statements GMAC people told you.
      2. The 1099-A for the deficiency balance, which was never followed-up by a 1099-C notice of cancellation. Talk to a tax lawyer to learn if there are any implications for receiving an A and no C.

      Regarding the Chase junior, I cannot answer your question without knowing more about the nature of this loan. The Mortgage Forgiveness Debt Relief Act applies to "forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes." Did you use your second mortgage to "buy, build or substantially improve your principal residence"? If yes, then the Act applies. If it was home equity loan used to consolidate debt (for example), then the Act does not apply.

      0 Votes

  • DS
    Apr, 2012
    Dennis
    We've been offered a mortgage modification by GMAC with a significant reduction of the unpaid balance. I understand that the forgiven principal is considered taxable income unless, among other things, the mortgage is for a principal residence (IRS Form 982). What if the mortgage was taken out for a principal residence, but because of the housing crisis, have been unable to sell our home, rented it out and relocated. Because it was our principal residence when took out the mortgage, can we qualify to claim this exemption on Form 982, even though we now live elsewhere?
    0 Votes

    • BA
      Apr, 2012
      Bill
      We do not know what standard the IRS uses to determine residency for the purposes of the Mortgage Forgiveness Debt Relief Act. One argument we have read online is the IRS should use the same standard for residency when determining any capital gains taxes owed:
      "if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its sale,"
      However, that is an argument and not a statement issued by the IRS. Your best source of information is a tax lawyer who has experience with mortgage issues. I realize my answer is not what you hoped for. However, I would rather give you a non-answer than one based on speculation.
      0 Votes