Individuals who receive forgiveness or cancellation from their home mortgage loans must report the discharged amount as income on their tax returns and pay federal taxes on the amount to the IRS. The Mortgage Forgiveness Debt Relief Act of 2007 is a federal law proscribing certain tax rules for individuals receiving discharges from their mortgage debts.
Background
The Mortgage Forgiveness Debt Relief Act of 2007 makes mortgage debt cancellation from a person's primary home exempt from taxation. As of March 2011, the act's provisions apply only to debts forgiven during the years of 2007 through 2012, according to the IRS. The act's tax exemption does not apply to discharged mortgage debts resulting from lender services not related to a decline in the value of an individual's home or services performed for a mortgage lender.
Amounts
The act allows homeowners up to $2 million of tax exemption (as of 2007) for loan cancellation from their primary residences' mortgages. However, married people filing separate tax returns receive a maximum exemption amount of $1 million, as of 2007. Although canceled mortgage debt falling below these amounts are exempt from taxation, individuals must still report them to the IRS when they file their regular yearly tax returns.
(Note to CE: the IRS website is unclear as to whether it is individuals or married filing jointly -- it doesn't say. I just changed it to say "homeowners." However, this website "http://www.IRS.gov/pub/IRS-pdf/p4681.pdf," page 8, seems to suggest the $2 million limit applies to both individuals and married people filing jointly.)
Forms
Individuals receiving mortgage debt discharges will receive IRS Form 1099-C from their mortgage lenders. This form will state the amount of canceled debt in box 2. A person should enter the amount shown on their 1099-C form on boxes 2 and 10 on IRS Form 982, the canceled debt return form. When filing their taxes, individuals receiving discharges from mortgage debts must attach Form 982 to their annual federal income tax returns.
Considerations
If individuals receive mortgage debt forgiveness in excess of the aforementioned dollar limits, they may still receive tax exemption for the extra amount under the IRS' insolvency clause.The IRS considers a person legally "insolvent" when the amount of her total liabilities, such as credit card debt or student loans, exceeds the value of her total assets, such as cash income or home equity. Additionally, individuals may receive tax exemption for their excess canceled debt by filing for Chapter 11 bankruptcy protection.
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