Questions and Answers on Home Foreclosure and Debt Cancellation
Below is a MRR and PLR article in category Finance -> subcategory Debt Consolidation.
Understanding Home Foreclosure and Debt Cancellation
Overview
The Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from discharge of debt on their principal residence, typically due to mortgage restructuring or foreclosure.
Key Points
Eligibility and Limits:
- Applies to debt forgiven in 2007, 2008, or 2009.
- Excludes up to $2 million of debt ($1 million if married filing separately).
- Doesn’t apply if the discharge is for services to the lender or unrelated reasons.
Impact on Tax Basis:
- The exclusion reduces the taxpayer's cost basis in their home.
Frequently Asked Questions
1. What is Cancellation of Debt?
When a lender forgives your debt, the canceled amount might be taxable. Initially, borrowed money isn’t considered income since there's an obligation to repay. Once forgiven, it becomes taxable income. Lenders must report this on Form 1099-C.
Example:
Borrow $10,000, repay $2,000, and have $8,000 forgiven. Generally, the $8,000 is considered taxable income.2. Is Cancellation of Debt Income Always Taxable?
Exceptions include:
- Bankruptcy: Debts discharged here aren’t taxable.
- Insolvency: Some or all debt might not be taxable if total debts exceed assets. Expert advice is recommended.
- Certain Farm Debts: If over half your recent income is from farming and the loan was from a regular lender, forgiven debt isn’t taxable. Professional guidance is advisable.
- Non-recourse Loans: Only the property can be repossessed upon default?"no personal liability means no debt income, though other tax issues may arise.
3. What are the Tax Consequences of Foreclosure?
Consider:
- Taxable Debt Cancellation: Not taxable for non-recourse loans.
- Reportable Gain: Foreclosures are treated as sales. Gains may be excluded if the property was a personal residence.
4. Can Foreclosure Losses Be Deducted?
No. Losses from personal property sales or foreclosures aren’t deductible.
5. Can You Provide an Example?
A homeowner buys a house for $170,000 in 2005, which is foreclosed in 2007 while worth $200,000. With $220,000 in canceled debt, insolvency still impacts the tax situation, since debts exceed total assets.
6. Disagree with Form 1099-C?
Contact your lender for corrections and keep all relevant records.
7. Received an IRS Notice?
Contact the IRS via the number on the notice. If unable to pay additional tax, consider a payment plan using the installment agreement form provided.
8. Where to Get Tax Help?
For unresolved tax issues, reach out to the Taxpayer Advocate Service. Additionally, Low Income Taxpayer Clinics (LITC) offer representation for those eligible.
For more detailed assistance, seek professional tax advice or consult resources at your disposal.
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