If your home was foreclosed in 2008, you should have received Form 1099-C from the mortgage holder. Yes, on top of the loss of your home and the situation that caused it, now you have to deal with income tax ramifications.
Mortgage Forgiveness Debt Relief Act of 2007
The good news is that since December of 2007, homeowners who lose their homes due to foreclosure do not owe income tax on the amount the bank forgave. This thanks to the Mortgage Forgiveness Debt Relief Act of 2007. In the past any difference between the amount you owed and the amount the bank sold the house for was considered income, and therefore taxed to you – the possibly out of work former homeowner.
So far the relief is temporary. If you lose your home after 2012, the old rules will apply. Let’s hope we’re all keeping our homes by then.
Eligibility for Non-Taxable Status of Mortgage Debt Forgiveness
You must meet following for mortgage debt forgiveness to be non-taxable:
- The mortgage must have been for your principal residence. (Vacation, investment or other properties are not eligible.)
- No more than $2,000,000 of forgiven debt can be excluded from taxable income. ($1 million for married filing separtely.)
- If part of the forgiven debt was a home equity loan used for purposes other than to build, buy or substantially improve your primary residence, that portion is still taxable.
- Short sales: If you were behind on payments and the lender agreed to let you sell the house for less than what was owed on the mortgage if all proceeds were turned over to the bank – you recieve the same favorable status.
- Forgiveness in the form of partial mortgage reductions or loan modifications that enabled the homeowner to remain in the home and continue making payments also qualify for the relief.
- You must 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 year.
What’s the Catch?
The current mortgage forgiveness relief is a huge benefit to struggling taxpayers today, but there will be a price to pay eventually. If a homeowner takes advantage of debt cancellation and keeps their home, they are required to reduce the basis (original price of the home) by the amount forgiven when they sell the home. This will create a larger gain in the future, possibly resulting in an increased tax bill.
Form 1099-C shows the amount of debt forgiven and the fair market value of any property foreclosed. Examine the information carefully and notify the lender if any of the information is incorrect. Pay particular attention to the amount of debt forgiven (Box 2) and the value listed for your home (Box 7).