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Mortgage Forgiveness Debt
Relief Act The Mortgage Forgiveness Debt Relief Act
of 2007 allows homeowners to exclude from gross income any
qualified principal residence indebtedness cancelled during 2007
through 2009. Debt reduced through mortgage restructuring, as
well as mortgage debt forgiven in connection with a foreclosure,
may qualify for this relief.
Amount realized from a short sale
If you do not make payments you owe on a loan secured by
property, the lender may foreclose on the loan or repossess the
property. The foreclosure or repossession is treated as a sale
from which you may realize gain or loss. This is true even if
you voluntarily return the property to the lender. If the
outstanding loan balance was more than the Fair Market Value of
the property and the lender cancels all or part of the remaining
loan balance, you also may realize ordinary income from the
cancellation of debt. The Fair Market Value is the price at
which a willing seller and a willing buyer will trade. You must
report this income on your return unless certain exceptions or
exclusions apply.
Borrower's gain or loss
You figure and report gain or loss from a foreclosure or
repossession in the same way as gain or loss from a sale. The
gain or loss is the difference between your adjusted basis in
the transferred property and the amount realized.
Amount realized and ordinary income on a mortgage debt. If
you are personally liable for the debt, the amount realized on
the foreclosure or repossession includes the smaller of:
- The outstanding debt immediately before the transfer
reduced by any amount for which you remain personally liable
immediately after the transfer, or
- The Fair Market Value of the transferred property. The
amount realized also includes any proceeds you received from
the foreclosure sale. If the Fair Market Value of the
transferred property is less than the total outstanding debt
immediately before the transfer reduced by any amount for
which you remain personally liable immediately after the
transfer, the difference is treated as ordinary income from
the cancellation of debt. You must report this income on
your return unless certain exceptions or exclusions apply.
In the past, this cancellation of debt income was reported as
ordinary income on Form 1040, Line 21. In order to qualify for
relief, the debt must be incurred in the acquisition,
construction, or substantial improvement of an individual’s
principal residence and be secured by that residence. The
balance on the loan must be less than $2 million or $1 million
for a married person filing a separate return. A refinanced debt
is also eligible for the exclusion, but only up to the amount of
the old mortgage principal just before the refinancing.
IRS Forms
1099-A and 1099-C
If you receive a Form 1099-A, Acquisition or Abandonment of
Secured Property, or Form 1099-C, Cancellation of Debt, for
their principal residence, you may be a candidate for this
relief. A lender who acquires a residence in a foreclosure or
repossession should issue Form 1099-A showing the information
needed for the taxpayer to figure the gain or loss to be
reported on Schedule D. However, if the lender cancels a debt on
a foreclosure and must file Form 1099-C because the amount of
debt cancelled is $600 or more, the lender may include the
information about the foreclosure or repossession on Form 1099-C
instead of on Form 1099-A.
If you receive a 1099-C form from a creditor, you must report
the amount of the canceled debt as income to the IRS even though
you have not actually received the money. The amount shown in
Box 2 of the 1099-C form is the amount that must be reported as
income.
Exemption
from 1099c from taxable income
• 1099 income from the short sale of an owner occupied principal
residence is exempt from income tax but must be reported.
• 1099 income from the short sale of rental property or a
non-owner occupied property does not automatically qualify
for an exemption from income tax. The canceled debt is reported
as ordinary income. This means all other ordinary expenses and
losses can be applied to the income. An account can help
you offset the income with expenses to mitigate or eliminate the
taxable impact of the 1099c income.
Exceptions from reporting income.
The IRS recognizes the following situations where a cancelled
debt does not have to be reported as income.
- Bankruptcy – the debt was already discharged through a
bankruptcy proceeding.
- Insolvency – your total debts exceed your total assets
at the time your debt was settled or deemed non-collectable.
- Indebtedness is due to a qualified farm expense.
Indebtedness is due to certain real property business
losses.
- Discharge of your debt was treated as a gift. This
is an extremely rare exclusion.
Insolvency
You are deemed to be insolvent if your total liabilities are
greater than your total assets.
Completing an insolvency worksheet will help you determine
if you were insolvent at the time your debt was discharged.
For example, if your total liabilities are $8,000 and your total
assets at the time are $6,000 you are insolvent in the amount of
$2,000. To determine the value of your assets use the fair
market value rather than what you paid for them or what you
think they are worth.
If a borrower is financially insolvent when he surrenders the
mortgaged property to the lender voluntarily or through
foreclosure there will be no imputed income. The property
does not have to be an owner occupied principal residence.
A borrower who files bankruptcy is presumed to be insolvent, so
that a bankruptcy debtor cannot suffer imputed income tax
liability because the bankruptcy discharges personal liability
under a mortgage note.
Helpful tips to avoid
problems if you have received a 1099-C
- If you settle your mortgage for less than the full
amount be sure to ask the creditor if they intend to submit
a 1099-C form to the IRS.
- The name of the creditor may not be readily recognizable
on the 1099-C form. The creditor may have sold the
debt to a third party collection agency or the name of the
parent company could be listed as the creditor.
- Look to see if the added income received from a
debt cancellation will move you into a higher tax bracket.
For a taxpayer in the 35% tax bracket in 2005, a $5,000
canceled debt could cost up to $1,750 in additional income
taxes.
- You cannot claim that you never received a 1099-C form
in the mail. Even if you do not receive a 1099-C form
you are expected to recognize ordinary income.
Deemed Sale
A foreclosure or short sale is considered the same as a sale or
a ‘deemed sale’. Some lenders are issuing Form 1099-A to
report the foreclosure on a principal residence but no Form
1099-C. If the taxpayer was personally liable for repayment of
the mortgage when the debt was created, Box 5 on Form 1099-A
should be checked “yes.” The abandonment is reported
as a deemed sale of the property on Schedule D. The
selling price would be the lower of Box 2, “Balance of principal
outstanding,” or Box 4, “Fair market value of property.”
If Box 2 is greater than Box 4, there could be cancellation of
debt, which would qualify for the mortgage relief income
exclusion.
Form 982
To claim the income exclusion, Form 982, Reduction of Tax
Attributes Due to Discharge of
Indebtedness, needs to be filed for homeowners who receive Form
1099-C for a home mortgage which was partially or entirely
forgiven during 2007. Form 982 was revised in February 2008 to
add two new lines to accommodate home mortgage debt forgiveness:
- Line 1e, “Discharge of qualified principal residence
indebtedness,” and
- Line 10b, “Applied to reduce the basis of your principal
residence.”
If Form 982 is being used as the result of foreclosure on a
principal residence to report the exclusion of forgiveness of
qualified principal residence indebtedness, only Lines 1e and 2
need to be completed. If, instead of foreclosure, the principle
residence was retained and a modification of the terms of the
mortgage resulted in the forgiveness of qualified principal
residence indebtedness, complete Lines 1e, 2, and 10b. In
either case, attach Form 982 to the client’s tax return.
Example:
Tom and Ann Spender bought a new home on June 23, 1990, for
$70,000. This was their principal residence until Tom lost his
job and they fell behind on their payments, eventually losing
the home through foreclosure on May 11, 2007. When the couple
walked away from their home, they still owed the bank $49,097.
Due to the depressed economy, the mortgage company sold the
house for $40,000 and cancelled the $12,618 debt remaining on
the mortgage that was not satisfied by the proceeds on the sale
of the house.
Under the new rules of the Mortgage Forgiveness Relief Act of
2007, they escape reporting the cancellation of debt as income
on Line 21 of Form 1040. Instead, Tom and Ann will report
this cancellation of debt on Form 982. On Form 982, check
Box 1e and enter the $12,618 of home mortgage debt discharged on
Line 2.
The foreclosure on the personal residence is treated as a
deemed sale for the lesser of the amount of the balance of the
principal outstanding or the Fair Market Value of the property.
Any gain is eligible for the §121 exclusion if the use and
ownership tests are met. Assuming the Spenders’ house has an
mortgage of $77,382 and the deemed sales price is $40,000, they
have a gain of $37,382 on the deemed sale [$77,382 - $40,000 =
$37,382]. However, the gain is excluded under Section 121 of the
IRS code as long as they owned and occupied the home as their
principal residence for at least two years during the five-year
period ending on the date of the foreclosure.
We are not lawyers or
accountants
The information here is intended to be
only illustrative and not intended for your specific individual
needs. We recommend you consult a lawyer and an accountant if
you want professional assurance that our information, and your
interpretation of it, is appropriate to your particular
situation.
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