This document provides information about tax rules regarding the cancellation of mortgage debt. It explains that forgiven mortgage debt is generally treated as taxable income, but a law passed in 2007 provides relief for forgiven mortgage debt secured by a primary residence until December 31, 2012. It details that the forgiven amount up to the original mortgage amount plus improvements can be excluded from income. It also answers questions about how the rules apply to short sales, foreclosures, refinances, and situations where a homeowner's debt is reduced but they remain in the home.

1. What You Need to Know about Cancellation of Mortgage Debt
Posted By susanne On March 11, 2012 @ 1:07 pm In Consumer News and Advice,Home Owner
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This column is brought to you by the NAR Real Estate Services group.
A lender will, on occasion, forgive some portion of a borrower’s debt. The general tax rule that applies
to any debt forgiveness is that the amount forgiven is treated as taxable income to the borrower.
Some exceptions to this rule are available, but, until recently, the borrower was required to pay tax on
the debt forgiven. A new law enacted in December 2007 provides relief to troubled borrowers when
some portion of mortgage debt is forgiven. However, this relief expires on December 31, 2012 and
NAR will be working to obtain an extension throughout the year.
Below is some general information you need to know about this law and cancellation of mortgage
debt.
General Rule for Debt Forgiveness
If a lender forgives some or all of an individual’s debts, the general rule is that the forgiven amount is
treated as ordinary income and the borrower must pay tax on the forgiven amount. Exceptions apply
for bankruptcy, insolvency and certain other situations, including mortgage debt.
Current Law for Mortgage Debt
(Jan. 1, 2007 through Dec. 31, 2012): A borrower can be excused from paying tax on forgiven
mortgage debt. The debt must be secured by a principal residence and the total amount of the
outstanding obligation may not exceed the original mortgage amount plus the cost of any
improvements.
Does the relief apply only to a sale?
No. The provision has broader application. Lenders might forgive some portion of mortgage debt in a
short sale (when value at sale is less than the amount owed) or in a foreclosure where the debt is
wiped out. In addition, if a borrower still living in the home is able to make an arrangement with a
lender that reduces the principal balance of a mortgage, the amount forgiven in that workout will not
be taxed.
Can the homeowners in a short sale or foreclosure claim a loss?
No. The loss is considered a personal loss and is, therefore, ineligible for either capital loss or ordinary
loss treatment.
What happens to the seller when mortgage debt is forgiven?
Until January 1, 2013, the homeowner will pay no tax on any forgiven amount.
Does this provision apply to a refinanced mortgage?
Only in limited circumstances. The relief provision can apply to either an original or a refinanced
mortgage. If the mortgage has been refinanced at any time, the relief is available only up to the
amount of the original debt (plus the cost of any improvements). Tax relief is generally not available
for second mortgages or home-equity lines of credit where the funds are not used for home
improvement. Any amount that is not eligible for the relief provision will be taxed as ordinary income.
How does the homeowner get the correct information to the IRS?
The lender is required to provide the homeowner and the IRS with a Form 1099 reflecting the amount
of the forgiven debt. The borrower/homeowner must file a Form 982 to reflect the amount forgiven
and to show the reason why the forgiven amount is not taxable. Any taxable portion of forgiven debt
will then be reported on the homeowner’s Form 1040 for the tax year in which the debt was forgiven.

2. What if a property declines in value but the owner stays in the house?
The provision would not apply. The provision applies only at the time of sale or other disposition or
when there is a workout (reduction of existing debt) with the lender.
Do all lenders forgive mortgage debt when property values decline or the home is in
foreclosure?
No. Some states have laws that allow a lender to require a repayment arrangement, particularly if the
borrower has other assets. Forgiveness of debt is always at the lender’s discretion.
Linda Goold is the Tax Counsel for National Association of REALTORS®.
Article printed from RISMedia: http://rismedia.com