Homeowners, through various avenues such as short sales, foreclosures and loan modifications, have stacked up billions of dollars in mortgage debt that has been forgiven by their lenders.  Here is the skinny on a few important facts that homeowners should be conscientious about when contemplating a short sale, foreclosure or a loan modification.

  1. Typically, when a lender forgives a debt, it relieves a borrower from having to repay that debt.  However, the amount of the debt is taxable income in the eyes of the IRS.  However, according to the Mortgage Debt Forgiveness Relief Act of 2007, you may allow you to exclude that income as taxable income up to $2 million of debt forgiven if the property was your principal residence. The limit is $1 million for a married person filing separate.  Check with your CPA
  2. You may exclude from your taxable income debt reduced through mortgage modification, as well as mortgage debt forgiven through a foreclosure.
  3. The debt must have been "purchase money" meaning the money must have been used to acquire the home, improve the home or build the home.
  4. Home improvement mortgages may also qualify for the debt forgiveness.
  5. Second or Third mortgages used for any purpose other than home improvement or acquisition do not qualify.
  6. Debt forgiven on investment properties, vacation homes, business property etc. do not qualify for this tax relief.
  7. You will most likely receive a Form 1099-C if your debt is reduced or eliminated.  This form must show the amount of debt that was forgiven. Make sure that the Form 1099-C is correct once received.

Please note: This above information is provided for informational purposes only and should not be construed as tax advise.  Please make sure to consult with your CPA should you have any tax specific questions.