People who have lost their homes due to foreclosure or who restructured their mortgage loans might qualify for tax deductions in which the Mortgage Forgiveness Debt Relief Act, but only for a limited time.

First enacted in 2007, the law was expanded through 2016 and “sunset” expired on January 1, 2017. Bill HR 2543 was introduced to Congress in May 2017 to further extend the law through 2018, but it is not over yet. For the time being, tax reduction is only available for bankruptcies or mortgage restructurings that occurred before January 1, 2017.

But if you qualified before that date and failed to claim this tax break, you still have a little time to file a modified tax return. Normally you have three years from the date you first submitted a return to change it.

The law allows you to close up to $ 2 million in debt waived or canceled by your mortgage lender at one of the main homes. Both mortgage restructurings and bankruptcies qualify. You can claim this tax reduction by submitting IRS form 982 with your amended tax return.


What is canceled debt income?

canceled debt

Anytime a lender cancels or forgives your debt, this is considered income for you and it is taxed accordingly. You accepted money that you were required to repay, and tax law believes that you effectively kept the money if you were unable to repay the debt. That makes the income-money come into your household-so you have to pay income tax on the amount unless an exception applies.

The IRS has this to say about it:

“Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income.”


Reporting requirements

debt requirements

Lenders must report debt cancellation to the Internal Revenue Service using Form 1099-C, debt cancellation, and the taxpayer must receive a copy of the form. This is your alert that your debt has been officially forgiven, so you must include the amount of your tax return. You would enter it on line 21 of form 1040 as “other benefits.”


Mortgage Restructuring and foreclosures

Mortgage Restructuring and foreclosures

If you lost your home by foreclosure or restructured your mortgage for a lower balance from 2007 to December 31, 2016, you don’t have to report the forgiven debt and you don’t have to pay income tax on that amount thanks to the Mortgage Forgiveness Debt Relief Act. Discharged debt in 2017 would also be eligible to be forgiven if there is a written agreement in 2016.

Although this tax-free exclusion normally applies to canceled mortgage debt of up to $ 2 million, it is reduced to $ 1,000,000 if you are married, but you will need a separate return. The house must have been used as your principal residence and the mortgage must have been taken to buy, build or make substantial improvements to the property.

Some mortgage debt will not qualify for this tax-free exclusion, so forgiven debt associated with them would be considered taxable income. Mortgage loans that do not qualify include mortgage loans, where the proceeds were not used to purchase, build or improve the residence, as well as mortgages for second homes and rental properties.


Other Tax-Free exclusions

Tax-Free exclusions

Although the fate of the Mortgage Forgiveness Debt Relief Act remains uncertain, the tax law provides for other ways that debt can be tax-free so not everything is lost to be canceled.

Canceled debts do not have to be included in taxable income if the debt was canceled in a bankruptcy case, if you were bankrupt at the time the debt was forgiven, or if the canceled debt was intended as a gift. Certain items or farm ownership may also be eligible for tax-free treatment.

The insolvency number exclusion is particularly relevant because it often applies to borrowers with mortgage loans or mortgages on second homes and rental properties. This insolvency provision can be useful to people who would otherwise not qualify for the Mortgage Forgiveness Debt Relief Act or if the law is not renewed for the coming years. Insolvency means that your debts are higher than the fair market value of your assets. It’s that simple. This is often the case for borrowers whose properties have fallen in value and who must now restructure their loans or give up their properties through foreclosure.