Mortgage Debt, From the IRS Perspective

Mortgage Debt Relief Act of 2007 allows the taxpayer not to include the income from the debt discharge on their main residence as income.  What qualifies for the relief then?  The debt that has been lowered because of the restructuring of the mortgage plus the mortgage debt that is forgiven related to foreclosure qualifies for the assistance. 

How about the years the mortgage debt before the foreclosure fiasco happened?  Can they be forgiven?  The answer is no because IRS specified that only the debt forgiven from 2007 to 2012 is qualified.  This is not a bad thing especially up to $2 million dollars of forgiven amount is eligible.

Mind you, there are some exclusions involved.  If the discharge is because of services done for the lender, then there is no deal.  In other words, if it is not directly connected with the person's financial problem or the lower value of the home, then it is not eligible. 

This is good because the loophole is plugged for some questionable dealings and only those in foreclosure distress through no fault of their own will be helped. There is more detailed information in Publication 4681.  Did you know you can call IRS and request to have this sent to you?  While you are at it, ask also for IR-2008-17.

It must be remembered though that any debt owed to someone who cancels or forgives it may be taxable.  This begs the question as to whether all income as a result of debt cancellation are always taxable.  The answer is not always.  Here are the exemptions where income from cancellation of debt is not taxable:

• Cancelled debts through bankruptcy are not taxable income.
• Debts cancelled to principal residence that are qualified are not taxable income.
• When you have more liabilities than assets, then the cancelled debts are not taxable.
• Debt cancelled that was incurred in the operation of a farm where more than 50% of the income during the last three years are earned, is not taxable.
• If the lender's only other option is to repossess the property that was financed and used as collateral, then any such debt that is forgiven may not be taxable. However, if such forgiveness is due to a foreclosure, then this does not lead to cancellation of debt income and may have other tax consequences.

There are other questions on mortgage debt that is related to the forgiven amount.  Are all forgiven and cancelled debts included in the Mortgage Forgiveness Debt Relief Act?  The answer is no because it applies only to those used to build, buy or improve the main residence.

In connection to the above, when debt is incurred to build, buy or improve the main residence that is secured by the home, then it qualifies for the maximum amount of $2 million dollars or if the married couple file tax return separately, then the maximum amount is naturally reduced to $1 million dollars.

How about for the debt incurred to refinance a home?  This qualifies for exclusion but up to a certain point.  And what is that point?  This refers to the balance of the old mortgage debt just before the refinancing was restructured. 

There are other questions but if you request for the aforementioned form, you should be good to go.  You will have enough information to work on forgiving the amount that is allowed within the law that was passed in 2007.  Then you will know what to do with your mortgage debt.

By Roger Guzman, M.D. and Evelyn Guzman

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