Can The Mortgage Forgiveness Debt Relief Act Help You?

Mortgage Forgiveness Debt Relief Act 2007There aren’t many ways to save ten thousand dollars at one time. But a law that’s been on the books since 2007 has been helping people do just that. If you’ve been involved in a foreclosure or a short sale recently (or if you will be soon) you should know about this law, because it could save you even more than ten thousand. It’s called the Mortgage Forgiveness Debt Relief Act of 2007.

It was enacted to help people involved in foreclosures and short sales by waiving the requirement that they report their canceled or forgiven mortgage debt as “income” on their tax returns. The reason this is such a huge deal is because those mortgage debts that have been forgiven or canceled can be a really big portion of your income – which leads to a major tax bill that people often can’t afford, especially when they are already dealing with the financial pain of losing their house.

Don’t believe me? Imagine you earn $50,000 per year and purchased a house for $250,000 that you ended up having to sell in a short sale. Because of the decline in value, your house sold for $200,000 and the bank forgave you $50,000 of debt (the difference between what you owed and what the house sold for). Under the typical rules, you would be required to report that as part of your income – which means your taxable income for that year would be double!

Holy cow, Batman! That’s a big tax bill for something you technically don’t get to enjoy anymore (your house).

However, this law allows you to waive those taxes until the end of 2012. Read below to see exactly how it works…

What Is The Mortgage Forgiveness Debt Relief Act?

It’s a law that Congress passed on December 20th, 2007, to help homeowners during the difficult period after the housing bubble popped. At the time, elected officials correctly saw that the large amounts of taxable “income” could bankrupt people across the country if nothing was done.

Which Types of Debt Are Eligible for the Mortgage Debt Relief Act?

Only debt resulting from a loan on your primary residence is eligible. So if your rental property got foreclosed on, it would’t be eligible. Keeping in mind that the house must have been your principal residence, any of these types of forgiven or canceled debt are eligible:

1. Foreclosure: The amount remaining on the mortgage would normally be considered income, but under the mortgage debt relief act it is not taxable
2. Short sale: The difference between what you owed and what the house sold for would normally be considered income, but is not taxable under the mortgage debt relief act.
3. Refinancing/Modification: Any amount forgiven or canceled in a refinancing or mortgage modification is not taxable under the mortgage debt relief act.

According to the IRS website, loans used to “buy, build, or substantially improve your principal residence, or to refinance debt incurred for those purposes,” are eligible. There is, however, a cap on the amount that is covered – $2 million per person or per family.

And to be eligible, the debt must have been forgiven or canceled between 2007 and 2012.

How Do You Normally Pay Taxes on Forgiven or Canceled Mortgage Debt ‘Income’?

Usually, your lender is required to submit a Form 1099 C to both you and the IRS specifying the amount of canceled debt, and you note it on your tax return as well. Then the IRS would tax you on that amount.

How Do I Apply for the Mortgage Debt Relief Act?

You simply need to do the following two things:

  • When you receive the Form 1099 C from your lender, look in box #2 to confirm the amount that was forgiven or canceled.
  • If the amount shown in box #2 appears to be correct, then mark that number down in the Form 982 and submit it with your tax return. (If the amount is not correct, you’ll need to contact your lender)

When Does the Mortgage Forgiveness Debt Relief Act Expire?

Remember, the law expires at the end of this year! That means, December 31st, 2012. Any foreclosure, short sale, or refinancing that you’re involved in would have to be 100% complete before then, in order to be eligible.

Will the Mortgage Debt Relief Act be Extended After 2012?

It’s possible, but we wouldn’t suggest you count on it!

Why Isn’t Anyone Talking About This? (And Where Can I Get More Information?)

Since the law was initially passed in 2007, there has not been much coverage of it recently despite the fact that the law is expiring soon. However, there have been some mentions of it recently – for example, in Fox News and the Los Angeles Times. We expect it to start getting more attention toward the end of this year.

If you want more information about how the law works, you can also read this publication by the IRS, which explains in careful detail each aspect of the Mortgage Debt Relief Act.

Going through a foreclosure or short sale is an incredibly frustrating experience on many levels. But if you have survived either of those in the last year, hopefully the information we’ve provided here will help you optimize your tax return and make the best decision regarding how to handle any forgiven or canceled mortgage debt you have. Who knows – the Mortgage Forgiveness Debt Relief Act could be a lifesaver!

And as always, let us know if you have any questions.

Image credit: stu99

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  • I feel so grateful for never having been there. My heart really goes out to anyone who lost their job or simply got in over their head. Good to know there are options that can make this horrible situation a little bit brighter.

    • Yes, I agree. Thankfully have never been there, but know those who have. Hopefully this will help some people.