Foreclosure Tax Relief Bill
In response to the mortgage crisis in the United States, then president George W. Bush signed into law the Mortgage Forgiveness Debt Relief Act of 2007, which eliminated taxes owed by homeowners who had debt forgiven as part of a home foreclosure or a short sale. The law took effect on Dec. 20, 2007. Prior to passage of this law, homeowners were faced with taxable income on the amount of the mortgage that went unpaid. This provision applied to debt cancellation from 2007 through 2009, but was extended to 2012 by the Emergency Economic Stabilization Act of 2008.
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Debt Forgiveness
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Debt forgiveness is the amount of a loan that remains unpaid. For example, if you borrow $10,000 but only repay $2,000 due to foreclosure or short sale, the remaining $8,000 is considered taxable income that you received. Under normal circumstances, this would be treated as normal taxable income by the Internal Revenue Service. However, the new law dismisses the amount of debt that is forgiven.
Exempting Canceled Debt
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According to the Internal Revenue Service, homeowners whose mortgage debt was partially or entirely cancelled between 2007 through 2012 are able to fill out a revised Form 982 and attach it to their federal income tax return. Taxpayers may exempt debt canceled on their principal residence if the balance of the mortgage was $2 million or less or $1 million for married people who file separate returns. The new Form 982 is downloadable from the IRS website.
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Mortgage Restructuring
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If a homeowner has debt forgiven by means of a mortgage modification by the lender, the Mortgage Forgiveness Debt Relief Act of 2007 applies them as well. However, there are some restrictions. The debt must have been used to buy, build or improve the principal residence. The debt used to refinance a mortgage that was already qualified for exclusion can be included, but it applies only to the amount of the first mortgage principal prior to refinancing.
Unqualified Loans
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Debt that is canceled or forgiven on second homes, rental and business property, and credit card debt and auto loans do not qualify for the debt forgiveness act. However, these debts may be forgiven in the case of insolvency during bankruptcy proceedings.
Form 1099-C Statement
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Borrowers who have had debt reduced or forgiven will receive by Jan. 31 a year-end statement, Form 1099-C, from their lender. This form must show the total amount of debt that was forgiven and the fair market value of property that was taken by foreclosure. Borrowers should check their Form 1099-C carefully and immediately notify their lender if there are any errors on the form.
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